The Federal Reserve's lenient monetary policy over a prolonged period has led to an increase in zombie companies: those that do not make profits and simply survive, or rather, subsist on debt.
To be more precise, these are companies that have been around for at least a decade and whose interest payments on loans exceed their earnings before interest and taxes.
As early as 2018, central investment banks such as Goldman Sachs warned that the situation was approaching critical. The move to ultra-loose monetary policy during the coronavirus pandemic only worsened matters.
In addition, the US authorities began buying corporate bonds to stem the tide of bankruptcies, effectively granting hundreds of distressed companies almost unrestricted access to credit markets.
It was expected that once regulators tightened monetary conditions, zombies would have no chance of survival, which could trigger a severe crisis in the financial system.
The reason is that borrowing new money would become prohibitively expensive, and they would be unable to repay their debts.
In fact, according to the American Bankruptcy Institute, the number of bankruptcies filed by businesses and consumers increased by 18% in 2023. However, this has not yet led to a total catastrophe in the market or the economy.
However, it is premature to assume that it will not lead to a disaster.
A study by Apollo Academics reveals that 41% of Russell 2000 companies are posting negative earnings. The Fed's rate hikes are affecting small and mid-cap companies more than larger ones.
Notably, the adverse effects are being felt especially in the technology, enterprise software, venture capital and related sectors, where companies are often experiencing profitability and revenue problems.
Therefore, it is crucial to closely monitor through the personal stock screener the debt positions of companies within these niches in your portfolio, paying special attention to their maturity dates to protect against additional risks.
What will all this ultimately translate into?
The Government is not preparing for a “tsunami” of companies seeking rescue through restructuring plans this year despite the cost pressures that continue to affect small businesses.
However, the rise in bankruptcies will shadow global economic activity and job growth in the coming years. If we manage to exit the high-interest rate cycle smoothly, perhaps the increase in small business insolvencies will not have a dramatic system-wide impact.