Of course, businesspeople fear bankruptcy, but it is an essential part of the structure of capitalism. Misallocated resources need to be reallocated and it can be a painful process. Up until the last year, we have been in a 30 plus year downtrend in interest rates and that has been quite the tailwind for American businesses in particular. Businesses that may not be extremely efficient can continually refinance their debts at lower and lower rates as years go on. That led to a significant number of public companies being labeled “zombie” companies. What that means is they essentially have to borrow more and more money to keep their doors open. Again, when interest rates are going down for decades it is understandable how inefficient companies continue to chew up capital. At some point however, the piper has to be paid and of course we had a lot of big company bankruptcies after the 2008 economic meltdown. Take a look at this chart courtesy of Bloomberg…
Taking a look at the numbers of companies going bankrupt with at least $50MM in liabilities, you can see that this is the third worst start (Jan through April) to a year since 2000. The alarming part is alluded to above and that is the fact that interest rates were brought down by the Fed in March and April in the years that had more large bankruptcies this early in the year. This year it looks like the Fed is CONTINUING higher with interest rates this week! We just had another bank taken over by the FDIC (First Republic) so again, the Fed is acting as arsonist and fireman simultaneously. The long downtrend in interest rates starting in the early eighties has been broken. We are not sure that interest rates stay up here, but it does appear that the Fed is trying to stick to its guns to leave interest rates up – even if they have to bail water in the banking system to do it.
We aren’t sure how this rolls out – but the good news is that earnings season is going reasonably well and although there are more layoffs in the employment world, the economy is stubbornly resilient. Part of that is clearly the Federal Government not backing off on its deficit spending – but we don’t think that can continue indefinitely. The private sector is starting to get nervous about the tightening in credit – and the Fed is trying to reduce its balance sheet. So if the government keeps sucking up investment dollars from the marketplace that could be financing private projects – that recession that everyone feels is irrelevant may actually come to pass. More on that next week…
Regards and good investing,
Greyson Geiler