Capital Thoughts: Corporate bankruptcy threatens the US economy

Capital Thoughts: Corporate bankruptcy threatens the US economy


Image courtesy of PxHere.

WeWork, the $47 billion office-sharing company, filed for Chapter 11 bankruptcy protection last week. They’ve made headlines, but all the bankruptcies you haven’t heard about pose a bigger threat to the American economy.

There is a lot of good economic news. The US economy recently recorded a 4.9 percent GDP growth rate. The unemployment rate remains low. Artificial intelligence promises to improve corporate productivity in the coming years. The company’s profits are expected to grow after several quarters of declines on an annual basis.

Not surprisingly, I remain invested in US stock markets. However, that doesn’t mean I’m Pollyanna. There will come a time when I will focus more on capital preservation. So, I look for evidence that things are getting risky.

The entire American economy is on a roll. The thing about this is that a recession doesn’t bring down the entire economy at once. Large-scale recessions occur after certain “pillars” collapse, and eventually everything collapses.

The Fed has raised interest rates by more than five percentage points since March 2022. The Fed’s last hike will likely be at its July 2023 meeting. The overall economy may not begin to feel the overall weight of those higher rates for about a year after the Fed hike the last one. We won’t know the timing for sure until that happens. But we can examine those columns to see if any of them are collapsing. And some are. For example, small businesses in the United States are feeling the pain of high interest rates.

There were 516 US corporate bankruptcies in 2023, compared to 372 in all of 2022 and 406 in 2021.

Chart courtesy of S&P Global.

The run rate of bankruptcies for 2023 so far is 688. It is not a stretch to think that this number will be reached. The Fed’s Survey of Senior Loan Officers on Bank Lending Practices (SLOOS) found that most banks “reported tightening standards or conditions on commercial and industrial (C&I) loans,” making it more difficult for companies to secure financing to maintain needed cash. . flow.

The chart below, from Bespoke, indicates that tougher lending standards for C&I loans are consistent with previous recessions.

Chart courtesy.

Reaching 688 bankruptcies would be more than in 2020, when pandemic-era government-imposed lockdowns caused permanent closures. And it was more than 2019 ago when I claimed there would be a recession in 2020 (I wasn’t predicting COVID-19, but I felt like there would have been a recession in 2020 even without the pandemic).

Of the 516 bankruptcies that occurred this year, the majority were small companies (at least relative to the companies that make up the S&P 500). There were some notable large companies (e.g., Yellow Corp, with 30,000 employees; Diebold Holdings, with 23,000 employees; Silicon Valley Bank, with 8,553 employees; and SmileDirectClub, with 4,850 employees) But these recent bankruptcies have been primarily a small business story.

The weakness in small companies is noticeable and perhaps predictable. Small businesses are traditionally the hardest hit by rising interest rates. This is meaningful because companies with 500 or fewer employees account for about 43% of GDP, according to the U.S. Chamber of Commerce. 63% of new jobs were created by companies with fewer than 100 employees between 1995 and 2021.

These small businesses are starting to feel a cash crunch due to the high cost of capital. This crisis comes at a time when banks have begun to restrict lending, choking off much-needed cash reserves. There is no light at the end of the tunnel. The Federal Reserve reported that banks expect β€œto continue to tighten standards on all loan categories.”

The labor market has also begun to suffer from the impact of rising interest rates. The latest labor market report revealed that 150,000 job opportunities were created in October 2023. The unemployment rate reached a strong 3.9%. However, this percentage is 3.9 percent compared to 3.4 percent earlier this year. This was the largest rise in unemployment since the great financial crisis of 2008-2009. The trend is towards further weakness.

The end of the US economic expansion may not be near, but I will be watching if it is getting closer.

Allen Harris is the owner of Berkshire Money Management in Dalton, Massachusetts, managing more than $700 million in investments. Unless specifically identified as original research or data collection, some or all of the data cited is attributable to external sources. Unless otherwise stated, any mention of specific securities or investments is for illustrative purposes only. The Adviser’s clients may or may not hold the securities discussed in their portfolios. The Advisor makes no assurances that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.

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