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November
01
2023

The Zombies are Dying
David Haggith

It's Halloween madness in the markets.

“If you had told me two years ago that the Fed would hike by this much in a short time, I would have said that they would leave dead bodies littered across the corporate credit landscape,” said former Fed Governor Jeremy Stein, who’s now a professor at Harvard University. “I really don’t have any good story to explain why things have instead been so resilient.”

I do.

True, that’s where things should be. It is also where we are going. The fact that we are not there yet is simply testimony to the massive amount of money-out-of-nothing the Fed created and the government threw at its citizens who are valued and identified by how much they eat (“consumers”). That is mostly what you hear the Fed and Treasury talking about now — the “resilient consumer” (who is holding the moribund economy up).

Many of those consumptive citizens, however, are running low on cash at last, and they are piling up debt, which they have learned to feel comfortable with during the years of almost free loans. Both are coming near an end. 

However, Stein is not talking about consumers. He’s talking about businesses that should be littering the landscape by now. Businesses got a whole lot more of that next-to-free money than “consumers” through massive grift programs that were known by titles like The Paycheck Protection Program. They also issued bonds at 2-3% interest and piled up cash piles with those bonds that are really just loans they eventually have to roll over at higher interest now that the cash raised by those bonds has been spent. 

Some of them are zombies, meaning they are only surviving because of those low -interest loans that gave them piles of operating cash to run off of because they cannot otherwise pay all their bills. All they could do was maintain the interest on those loans. Now the money is spent, and they can’t qualify for more at higher interest, and so they cannot pay off their bonds as they mature.

However, one of the headlines today is that the zombies are now dying like they are supposed to and should have done and would have done long ago if they were not rescued by the Fed and feds, going as far back as the Great Recession. That is to say, if we had just let capitalism do its dirty work that prepares the economic soil for the next new shoots of business to have room to grow.

The more money these zombies stockpiled in advance or the longer the duration they ventured for on their bonds, the longer they can hang on. There is a lag time between interest going up and the day the zombies hit bottom and have to go for more “cash” at the cost of that big interest and discover they can no longer qualify.

“There’s a lot of uncertainty around lags,” Fed Chair Jerome Powell said at an event earlier this month. “One of the reasons why we have slowed down significantly this year is to give monetary policy time to work.”

However…

“The bite is coming. It is going to require a bit more patience on the part of the Fed,” said Conrad DeQuadros, senior economic advisor at Brean Capital LLC, which is calling for a recession next year. “Corporate spreads are extremely tight and I think they are going to go wider if we are right on the economic outlook in 2024.”

Oh, it’s coming alright, and the zombie bite is doing to be deadly for the zombies and there are quite a few of them. Already 516 companies have filed for bankruptcy this year, but the jaws are gaping wider on credit spreads and will soon be wide enough for those long-in-the-tooth bonds at the top of high-yield junk to swallow a lot more.

One of the articles I laid out for or five years ago when predicting how the Everything Bubble Bust would go down once the Fed started QT and interest hikes again was about the crash coming in zombie corporations once that tightening began. As with housing, as with bonds, as with stocks, we are now seeing that crash developing, too.

The thing with zombies, if you’ve ever watched the movies, is that sometimes you don’t even know which ones are the zombies until they bite you. So, it will be with some of these corporations: we’ll be surprised to find out which ones are the zombies and how big and well-known they are until they bite their piece off the economy by firing everyone and defaulting on all their debt as they die.

The zombie death march has begun.

Seeing the Great Recession Before it Hit

My path to writing this blog began as a personal journey. Prior to the start of this so-called “Great Recession,” my ex-wife had a family home that was an inheritance from her mother. I worked as a property manger at the time, and near the end of 2007, I could tell from rumblings in the industry that the U.S. housing market was on the verge of catastrophic collapse. I urged her to press her brothers to sell the family home before prices dropped. The house went on the market and sold right away — and just three months before Bear-Stearns and others crashed, taking the U.S. housing market down for the tumble. Her family sold at the peak of the market.

 

 

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