Beware the Debt-Heavy: The Risks of Economic Cycles

Deep cyclicals pose significant investment risks due to their recent performance during a stimulus-fueled economy. Although these sectors, like building products, thrived as consumers invested in homes, the prolonged effects of rising interest rates and increasing consumer credit delinquencies might lead to challenges. Investors should avoid highly leveraged companies in discretionary areas like leisure and travel, especially if they haven’t hedged their floating interest rates. A potential future increase in defaults is likely as middle and lower-income consumer spending slows down, despite current market resilience. Inflationary pressures have allowed some businesses to elevate revenues and cash flows, temporarily mitigating default risks; however, underinvestment in crucial areas could exacerbate issues, leading to competitiveness loss and significant financial distress when defaults do occur.