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Mid-market earnings soar to record, but Golub warns about inflation

The Golub Capital Altman Index has clocked 16% earnings growth for the market in first two months of the year, but the firm's CEO says policy creates “very substantial risks” for the economy.

Earnings growth of mid-market private companies surged to a record 16.3 percent in the first two months of the year, compared with the same period a year ago, according to the Golub Capital Altman Index. The first-quarter earnings growth also outpaced the 14.9 percent year-over-year increase seen in the fourth quarter of 2020.

“We’ve been seeing a boom building and the boom is here,” Lawrence Golub, chief executive officer of Golub Capital, told Private Debt Investor in an interview. But he also expressed concerns about inflation.

Lawrence Golub

The latest results are the last to compare pre- and post-covid conditions. As such, Edward Altman, who has been producing the index with Golub since 2013, said the data “likely understates the strength of the first quarter of 2021” because it doesn’t capture the negative impact of the shutdowns last March. Altman, a leading expert and scholar in the credit markets who also advises foreign central banks, is a professor emeritus of finance at the NYU Stern School of Business.

The pace of revenue growth of middle-market private companies also picked up, rising 3.2 percent in the first two months from the 2020 period after growing 2.9 percent in the fourth quarter.

Nevertheless, Golub has concerns that fiscal and monetary stimulus is creating “very substantial risks” for the economy and inflation. He noted that “our current fiscal and monetary policy is not logically, quantitatively linked to the observable output gap”. Aggregate demand has been reduced by approximately $300 billion year-on-year because of the pandemic, he said, while the recent fiscal stimulus – which hasn’t yet flowed into the economy – has injected nearly $3 trillion into the economy, nearly 10 times the output gap.

The situation is no better on the monetary side. The path of inflation is uncertain, but “Jay Powell and the Fed are speaking as though they have a Pollyannaish vision of risks”, which could be problematic if inflation becomes sustained, he said. In addition, he noted that prices of such commodities as copper, wheat and lumber have “skyrocketed” from a year ago, and pointed to the latest report on consumer prices, which showed the CPI spiking 0.6 percent in March from the previous month and 2.6 percent from a year ago, exceeding analysts’ estimates.

But David Rosenberg, founder, president and chief economist and strategist of Rosenberg Research, told PDI that the pandemic “has unleashed a prolonged period of noise in the pricing data.” That is why he thinks the Fed isn’t overreacting, nor does he believe it should. Rosenberg also noted that even with the lags from prior dollar weakness and the commodity boom, core goods CPI “only eked out a 0.1 percent gain in March and has shown no net change over the past six months.”

Three inflationary scenarios

Still, Golub worries that the distortions in the numbers from those who are receiving supplemental jobless benefits, coupled with covid-related anxiety about rejoining the work force, could create “a lot of pressure on wages”. That, along with potential supply constraints, could present problems.

The executive noted that he sees three possible inflationary scenarios, with evenly balanced risks that one of them will develop. The first is a temporary burst of inflation, which dies down quickly as people return to work. The second is that inflation remains sustained, and the Fed, more worried about employment than inflation, continues to keep interest rates low. That would be a setup for “multi-year, sustained inflation”, he said. The third scenario is that the Fed raises rates earlier than expected and “probably triggers a modest recession.”

Golub said the mid-market index reflects something of a bifurcated economy, with sectors such as travel and entertainment that were more seriously affected by the pandemic still experiencing difficulties. “Everything else has been doing great since last summer,” he said. The index measures the median revenue and growth in earnings before interest, taxes, depreciation and amortization of more than 150 private companies in the loan portfolio of Golub Capital, a leading middle market lender with more than $35 billion of capital under management.

Although the companies represented in the index are drawn from a wide range of industries, it has limited exposure to some of the sectors that are most severely impacted by covid-19, such as hotels. But Golub noted that the index also doesn’t reflect residential construction, which provides something of a counterweight to hotels.

“Part of this profit growth comes from private-equity firms taking decisive action to put more capital into companies and work with CEOs” when the pandemic hit, he said. The index results “demonstrate the benefits that private equity brings to the US economy”.