The Human Impact Of The Zombie Company Crisis
A Look At How Bad Unemployment Could Get
The 2-year high inflation/aggressive Fed tightening cycle has featured one undeniable attribute - a robust labor market. Even after monetary conditions have tightened and corporations have had to grow more accustomed to a more grueling financial environment, companies have kept hiring and raising wages to attract and keep employees. This has been a major reason why the financial markets haven’t performed worse in 2023. A lot of investors believe that as long as the jobs market remains healthy, risk asset prices should too.
It won’t be that way forever though. In fact, it may not be that way much longer at all. Retailers have been warning for several quarters about a slowdown in consumer activity. Manufacturing is in contraction all around the world. The home construction market is slowing down rapidly as a lack of home affordability and high mortgage rates are severely impeding activity. A lot of signs are pointing to a reversal in the labor market even though we haven’t really seen it in the monthly numbers yet.
The area of the market that has me particularly concerned is smaller companies. We know that these are the businesses, on average, that are in a more challenging financial position. These are the companies that are more reliant on debt to fuel growth and they’re also the ones that are going to be disproportionately affected by rising interest rates and the impact of needing to refinance at higher rates.
You’ve probably heard the term “zombie companies” a few hundred times. There’s no one universal definition for what qualifies a company as a zombie, but the generally accepted idea is that it’s a business that isn’t generating the income or cash flows necessary to cover the interest expense on its outstanding debt. If you can’t cover the cost of borrowing money, then 1) no financial institution is probably going to lend you any more money and 2) even if you could, it leaves nothing left over for growth and investment. Zombie companies are really just living on borrowed time and the huge shift north in the yield curve over the past couple of years could very well push them over the edge.
As it stands right now, it’s estimated that roughly 1 in 8 companies qualifies for “zombie” status.
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