Chief strategist at a $1.3 billion asset manager explains why ‘zombie’ companies can trigger waves of default and sharp economic downturns amid rising interest rates, and what investors can do as risky assets simultaneously fall share


  • Mike Green is a Senior Strategist at Simplify Asset Management, managing $1.3 billion in assets.
  • He warned of the status of a “zombie” company in an environment of rising speed.
  • He offers a path for investors who may be facing a wave of corporate defaults.

The toughest markets in years to come could be even more brutal as “zombie” companies can swarm and shut down.


Federal Reserve

A chief strategist at a $1.3 billion asset manager warns of a rate hike.

Hedge fund veteran Mike Green, who once managed the personal capital of billionaire Peter Thiel, points to the “unusual pain” in the high-yield market as a sign of what was to come.

in a rising market


volatility

The high yield spread widened to around 400 bps as of May 10, according to Ned Davis Research, with the sector recently downgrading to neutral or market weighted. iShares iBoxx $ High Yield


debenture

According to Morningstar data, ETF (HYG) fell 10.44% this year.

The continued underperformance of junk bonds could have far-reaching implications for the economy. Because as interest rates rise, these highly leveraged, unprofitable “zombie” companies that will increasingly struggle to cover the cost of paying off debt make up about 10% of all publicly traded companies. According to % of private companies in the United States Fed report From July 2021

Number of zombie companies in the US


Federal Reserve


By Green’s definition, this number could double because it classifies a company as a “zombie” whose debt repayment costs are greater than or equal to its earnings.

“That means 100% of the cash flow should be used to pay off debt,” Green, senior strategist at Simplify Asset Management, said in an interview. “There is no capital left for growth. There is no capital left to pay off the amount of the debt. As maturity approaches, it is within its ability to refinance the debt.”

A wave of corporate bankruptcies expected

In his view, the unprecedented monetary and fiscal policies implemented over the past two years to support an economy afflicted by the pandemic have created a way for “zombie” companies to continue to raise funds from investors and refinance to lower debt repayments. opened.

But as inflation soared, exacerbated by Russia’s invasion of Ukraine and China’s zero-corona policy, the central bank aggressively raised interest rates and tightened financial conditions. As interest rates rise, “zombie” companies that need to refinance in a year or two are likely to face bankruptcy or bankruptcy in the near future, Green said.

Similar dynamics are taking place in the housing market. Highest Mortgage Rates Over 10 Years It has made it more difficult for many Americans to become homeowners. The two impacts of higher interest rates could slow the economy much faster than the Fed had anticipated, making it increasingly difficult for central banks to plan for a soft landing.

“I expect we’ll see an increase in the number of defaults,” he said. “I think the risk is greater on the corporate side, but I would also emphasize things like commercial real estate.”

Clearly, junk bonds issued by “zombie” companies fell from $70 billion at the end of 2019 to $30 billion at the end of 2020. Bloomberg, citing a study by Goldman Sachs. Also, the aforementioned Fed report We found that “zombie” companies that were “few and generally small” did not represent “a distinctive feature of the US economy.”

‘Bid or pass for safety’

But when the economy is slowing, a surge in corporate defaults can have devastating consequences.

“Nightmare scenario, what I’m most worried about is that we


recession

The purchasing power that entered the market is reversed as people leverage their financial assets to cover their current spending,” Green said.

in


bear market

Although some investors are recognizing the value of holding cash and preserving capital, the cost of derivatives-based hedging and downside protection strategies has risen significantly, he observed.

Meanwhile, the traditional 60/40 portfolio of stocks and bonds underperformed as risky assets increasingly correlated in the face of inflation.

“There isn’t much for investors to do, so start a bid for safety or decide you can pass it,” he said. “It’s a very, very challenging environment.”

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