We are only a little over one year into the Donald’s Presidency and what we know most for sure is that our new President loves debt. Not only did debt and deficits get the cold shoulder in the recent State of the Union, Trump played “Let’s Make a Deal” with the Lords of the Swamp Mitch and Chuck to increase government spending by 13% over current levels. We also know that he prefers a weaker dollar, which he hopes will engender balanced trade—along with trade tariffs it now seems. But most of all, he loves as a rising stock market that he views as a report card for the administration and his success.
But, interest rates have already begun to rise due to the soaring National debt. The Treasury is also borrowing about $1 trillion in this fiscal year–nearly twice the amount from the year before. And, the Fed goes full throttle into Reverse QE come this fall to the tune of $50 billion worth of asset sales per month. Therefore, as rates rise the risk premiums on equities are shrinking fast, all these headwinds will cause the stock market to head lower; and that storm has already begun.
Losses are now piling up across the fixed income spectrum. And companies on the margin, known as Zombies, will be the first casualties from a decade of cheap credit that has become paramount for their survival.
The Bank for International Settlements defines Zombie companies as having ten years or more of existence, “where the ratio of EBIT (earnings before interest and taxes) relative to interest expense is lower than one.” In other words, a company that perpetually needs to restructure debt to survive, and is unable to cover its interest expense with operating profits.
Today it is estimated that 10.5% of firms are in the Zombie category. According to Moody’s and Standard and Poor’s, “debt repayment capacity has broadly weakened globally despite ultra-low rates and ample liquidity.”
UBS research analysts are anticipating economy-wide interest payments will rise by 7-8% in 2018, requiring an equivalent increase in EBIT to offset the increasing costs. If significant top-line growth doesn’t pan-out, the Banks who finance these “Walking Dead” companies will likely be stuck with the tab.