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Expect Lower EPS, Fewer Dividends As Fed QE Exit Impact

Investors could see corporations return less capital and report weaker profits as the era of cheap debt appears to be winding down.

Corporate bond issuance has collapsed to the lowest level since late 2011 amid fears the Federal Reserve will soon taper the pace of monetary stimulus, sending debt yields of all kinds sharply higher.

June bond sales in the U.S. totaled $43.9 billion through Thursday night, down from $127.5 billion in May, according to Dealogic. The number of issuers tumbled to 72 from 188.

A similar trend can be seen in corporate debt globally, and municipalities have withdrawn planned bond sales as their borrowing costs soar. Sovereign bond yields have spiked as well, especially in emerging markets.

Funds holding debt of all kinds have sold off sharply. Investors pulled $61.7 billion from U.S.-listed bond mutual funds and exchange-traded funds in the month to June 24, TrimTabs Investment Research said, easily topping the previous record outflow of $41.8 billion set during the financial crash in October 2008.

It marks a sharp reversal from just a few months ago. In April, for example, Apple (AAPL) set a corporate-bond record by selling $17 billion of debt amid demand that topped $50 billion.

Bottom-Line Boost

Companies had rushed to load up on cheap cash, despite the economy offering scant encouragement to invest and expand.

So they instead used the easy money to refinance and cut debt-servicing costs, providing a boost to the bottom line as tepid growth held back the top line.

"It definitely helped on the earnings side," said Andy Richman, managing director of fixed income at SunTrust's (STI) investment advisory.

Q1 revenue from S&P 500 companies was flat vs. a year earlier, according to Thomson Reuters, which sees Q2 growth at 1.8%.

Companies also showered shareholders with dividends and stock repurchases. The start of the year saw a record number of dividend hikes, following a flood of payouts at the end of 2012 ahead of tax hikes.

The money was used for mergers and acquisitions too, and 2013 began with a flurry of megadeals, like $28 billion for Heinz and $24 billion for Virgin Media, though the pace has slowed.

Roll Over

But any companies that need to roll over maturing debt with new borrowing will see higher rates now. And firms that didn't use the debt to invest in their operations when borrowing costs were low may suffer as the economy picks up again, said Minyi Chen, operating chief for TrimTabs Investment Research.

"These companies usually will underperform the market," he warned.

If rates get high enough, companies may start issuing more equity again to raise money, diluting existing shareholders and earnings, he added.

But borrowers that extended the maturity of their debt won't need to issue new bonds for a while, Richman noted. Rates are still low historically, and issuance could rebound if they stabilize.

For now, debt issuers and buyers are waiting for the new equilibrium point, said William Larkin, a fixed-income portfolio manager at Cabot Money Management.

It's unlikely companies will go on another refinancing wave, un less the economy tanks and sends yields back down again, he said.

But he is skeptical the bond market has completely shifted to a downturn, saying investors are overreacting to the Fed's stimulus outlook. A key tipping point will be if the 10-year Treasury yield reaches 3%.

"People are going to look at the game differently," he said. "The herd is going to be really spooked."