What Are The Zombie Stocks? AND WHY THE DEVELOPING RECESSION WILL PROBABLY BE MUCH WORSE THAN IS CURRENTLY PRICED INTO MARKETS
Business
We remain surprised (even shocked) at the lack of investor concern about the depth of the developing global recession that continues to be reflected by capital markets. The evidence (both economic and geopolitical) that we can anticipate a sharp recession and significant reductions in corporate earnings estimates in the coming months continues to build.
An example of the level of investor apathy has been highlighted by the market’s apparent repeated surprise at the Fed’s entirely predictable (to us) comments that that it remains focused at lowering inflation. The result has been a series of sharp market rallies built on hopes of a “pivot.”
These rallies have become followed by decisive declines when reality again asserts itself.
The Fed’s comments have not been surprising to readers of the Global Investment Letter. Our view was that consensus opinion was far too optimistic, which proved to be the case, and still is.
The accompanying chart illustrates one reason why we believe the recession will be far sharper than consensus. The percentage of “zombie” companies in the Russell 3000 index is at its highest level in history. Far higher than was seen during the internet bubble, a “zombie” company is defined as one that cannot pay the interest on its debt from operating revenues.
The continuing rise in interest rates will push the percentage of “zombies” even higher.
As a result, ultimately produce a wave of debt defaults that will have significant negative consequences for the economy and markets. These negative effects will find themselves exacerbated by the shattering of the apathy that currently pervades markets. An apathy which will serve to deflate asset prices.
The punishing effects of rising interest rates will not become confined to the so-called “zombies.”
However, will become felt throughout the very highly levered global financial system.
A set of economic and geopolitical catalysts for volatility are in place that we expect will produce an unusual level of both short and long-term market volatility. The economic and geopolitical volatility that we believe will come to define the 2020s will produce considerable risks. But will also produce great opportunities for the well-informed disciplined investor.
Each month in the Global Investment Letter I update my investing activities. As well as comment on major global equity, fixed income, currency, and commodity markets.
Written by Jonathan Baird, CFA
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What Are The Zombie Stocks?
