Beware the Market’s ‘Zombie Apocalypse’ – DailyWealth

Steve's note: The Melt Up is back on. But as a DailyWealth reader, you also know the other side of the story... the inevitable, crushing Melt Down. That's why today, we're sharing a warning from my colleague Mike DiBiase. He explains that stimulus efforts will save many companies in the short term but in the long term, many are headed to zero...

The pandemic has led to lower sales and ever-increasing piles of debt for most people and companies. And that's only going to make another growing problem worse...

I'm talking about "zombies." These are companies that can't afford their debt. They don't earn enough profits to cover interest... let alone repay their debt when it comes due.

They're like the walking dead... only kept alive by creditors willing to lend them more money to pay off their debt as it comes due.

Even before the COVID-19 pandemic caused the economy to slide into a recession earlier this year, the number of zombie companies in the U.S. was approaching an all-time high.

And now, it's even worse...

A record 18% of U.S. companies are zombies today, according to the Bank of International Settlements.

That's higher than the 14% before the last financial crisis... and it's even higher than the previous peak of 17%, set back in 2001. Take a look...

To put it simply, corporate debt has never been more burdensome than it is right now... Nearly one in five U.S. companies can't afford their debt. That's an alarming statistic.

As the recession drags on, with many companies still struggling to bounce back from the pandemic-related shutdowns, we expect the percentage of zombies to soon surpass 20%.

The next chart tells a similar story... It shows U.S. corporate debt as a percentage of cash profits. The higher the ratio, the more burdensome the debt... and the lower the chances it will be repaid. You can see that this ratio is also now higher than it has ever been...

The truth is, many companies have only been able to keep paying their bills during the COVID-19 pandemic by borrowing. But you can't borrow yourself out of a crisis. Even if a COVID-19 vaccine became widely available tomorrow, this debt wouldn't go away.

Eventually, all of this record-setting debt must be repaid or refinanced.

For many companies, the shift to a remote and digital economy means sales and profits will never recover to pre-pandemic levels. And with lower sales and profits for these companies, their prospects are looking less likely with every passing day.

That leads me to a simple conclusion... Much of this debt won't ever be repaid. The only way it will be cleared off the books is through bankruptcy.

We're certain to see a massive wave of bankruptcies in the coming months and years. It's just getting started...

So far this year, 124 U.S. companies have defaulted on their debt, according to credit-ratings agency Standard & Poor's ("S&P") including 57 in the second quarter. That represented the highest number of quarterly defaults since 77 companies defaulted in the second quarter of 2009, at the peak of the last financial crisis.

You can tell where the default rate is headed by looking at the number of credit downgrades. This year, more than 2,100 companies already have been downgraded. That's already 40% more than the previous annual record of roughly 1,500 downgrades in 2009.

While downgrades are at all-time highs, corporate credit quality is at an all-time low...

The number of companies with the lowest credit ratings ("B-" or lower) that are on negative credit watches or with negative credit outlooks from S&P are known as "weakest links." And the number of weakest links hit an all-time high in September. The U.S. is home to more than 400 of these companies.

Here's why that's important... The default rate increases dramatically the further you go down the credit ladder. The default rate for the weakest-link companies is around five times higher than the overall high-yield default rate.

In other words... with a record number of weakest links muddling through a weak economy, I expect the default rate to soar. And when it happens, you will see fear return to the stock and bond markets once again. It could make the sell-offs in March look like blips on the radar.

Good investing,

Mike DiBiase

Editor's note: You don't have to be a victim when fear returns to the markets. In fact, that's when Mike's unique investing strategy really shines... The greater the fear, the larger the profits. Just ask one of our subscribers, who used the same approach in 2009 to make a 660% total return in three years... Get the details here.

Beware the Market’s ‘Zombie Apocalypse’ – DailyWealth

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