Morgan Stanley and UBS Warns of Heightened Risk of U.S. Recession and to Avoid Corporate Credit

The cheery folks out of both Morgan Stanley and UBS are telling clients to fear the end of the BREXIT blade, for comes with it is an undeniable storm that is bound to rip credit markets to pieces. They’re talking corporate credit here, the type of sordid horseshit that almost tipped over in February of this year–only to revive with the uptick in crude.

“Despite the urge to step in and buy U.S. credit at modestly wider levels than a few days ago, we recommend patience,” Morgan Stanley strategists led by Adam Richmond wrote in a note to clients Monday. “While the full impact of the U.K. leave may not be known for some time, the U.S. economy is not in a position to withstand a large shock.”

High yield debt has been widening–because they truly do suck. More than that, the vast majority of it is in the basic resource space–a sector of the market which has enjoyed the lionshare of gains since the March lows.

According to Exodus, there is upwards of $150 billion in distressed basic resource debt. But right behind it is another $450 billion, which will become distressed should their share prices continue to slide. In other words, the BREXIT issue, although concerning, pales in comparison to the type of ripple effect a large scale credit event in the oil and gas space could impose.

UBS’s Stephen Caprio is advising investors to resist deploying new cash to buy bonds on the cheap for now as Brexit increased the likelihood of a U.S. recession to 34 percent. That along with a stronger U.S. dollar, low oil prices and banking sector stress could upend vulnerable credit markets. In that case some high-yield and investment-grade companies may struggle to access debt markets, according to UBS.

“We do not believe investors should be buying Friday’s dip in credit yet,” Caprio wrote in a note to clients. “It is not often that an exogenous shock has hit so late in the credit cycle with central banks already at the zero bound.”

The U.S. economy and company creditworthiness are already weak enough that it may not take much to spark a deeper sell-off in corporate bonds, according to Morgan Stanley’s Richmond.

There were signs economic risks were rising even before the Brexit vote: U.S. corporate profits are down 15.5 percent from a peak in the fall of 2014 and business investment has deteriorated, Richmond wrote.

What’s more, companies — even large blue-chips — are about the least creditworthy they’ve ever been as they’ve borrowed rampantly in the face of weak earnings, according to Morgan Stanley.

“A catalyst is here,” Richmond wrote. “The worry that global growth is weakening and central banks can’t do much about it, which was prevalent earlier this year, won’t be far behind.”

There you have it, folks. The BREXIT vote has created an environment that is onerous to the increase of crude prices. In turn, there is an increased likelihood of a large scale credit event in the oil and gas space, one that is teetering on the brink of destruction. Should this occur, a recession is all but a forgone conclusion.

I haven’t even mentioned China in this post, something we’ll leave for another article.