Are investors in denial about how dim the outlook is forAmerican businesses?

That's the question Société Générale's Andrew Lapthorne, globalhead of quantitative strategy, posed to his bank's clients.

“Asset valuations are extreme; returns are poor, the probabilityof losses is high, and the ability to recover any losses quickly islow,” he writes.

In particular, the strategist sounded an alarm over thestate of corporate America's balance sheet. Company spendingexceeds cash flow by a near-record amount—a fundamentallyunsustainable situation—as net debt continues toincrease at a rapid pace.

In many cases, companies have used debt to repurchase their ownstock, flattering their bottom-line financialperformance. While not all buybacks are financed by debt,Lapthorne did note a correlation between net repurchases and thechange in corporate indebtedness.

­“U.S. corporate balance sheets are a major risk going forward,”he says. “U.S. corporates are massively overspending.”

To be fair, servicing this debt load isn't as onerous as itmight appear, because of low interest rates. And despitethe recent steepening of corporations' yield curve, companies havecontinued to extend duration, which offers them more certaintyabout what their interest payments will be over the long term.

“For corporate credit, there's very little concern aboutshort-term coverage from the market,” write analysts at BespokeInvestment Group. “We note that maturities continue to creep upslowly; despite higher spread costs, corporates are generallyborrowing further out the curve and 'locking' low rates.”

But over the long haul, the performance of stock markets will beprimarily driven by earnings increases—and the level of corporateindebtedness implies that any latitude to boost earnings per shareby shrinking the denominator is limited.

Corporate profits in the U.S., meanwhile, have declined for fiveconsecutive quarters. As Bloomberg's Matthew Boesler remindsus, the combination of near-record corporate debt-to-GDP, recordlow return on equity, ever-higher labor costs, and subdued pricingpower doesn't paint an inspiring picture for growth.

U.S. profitability is on a “cyclical downtrend,” Lapthorneconcludes.

Copyright 2018 Bloomberg. All rightsreserved. This material may not be published, broadcast, rewritten,or redistributed.