Maybe you’ve heard the terms “zombie stock” or “zombie company” before…
These companies are dead on their feet. They’ve taken on way too much debt.
Despite that, something odd has kept them walking around far longer than expected…
Near-zero interest rates.
You see, low rates mean that it doesn’t cost a lot to borrow money. That makes it easy for companies to fund their operations with debt, rather than growing organically.
Cheap debt can keep zombies walking for ages. And the problem is shockingly widespread…
The Federal Reserve estimates that zombies make up around 10% of all public companies. And as crazy as it sounds, the Fed is largely responsible for getting us into this mess.
However, the central bank is now ready to go on a zombie hunt. And as I’ll explain today, you don’t want to get caught in the wrong investments as everything plays out…
Let’s start with a bit of history…
The Fed slammed interest rates to near zero all the way back in 2008 in response to the housing crisis. It wanted to put as much gas into America’s economic engine as possible.
It worked… The U.S. economy bounced back stronger than ever. But with debt so cheap, the Fed’s action also had a side effect… It led to the rise of the zombies.
As the Fed “normalizes” rates after a crisis, those companies typically die off naturally. But when it came time for the Fed to take its foot off the gas this time, something went wrong…
You see, the Fed started raising rates at the end of 2015. And it looked like it might pilot the U.S. into a so-called “soft landing” for the first time ever, gently cooling off the economy after a long boom.
But then, in early 2020, COVID-19 hit the world like a meteor. And the Fed slammed interest rates back to zero.
You can see this saga play out clearly on the following chart…
The Fed has kept rates at less than 3% for over a decade. And for most of that time, rates were near 0%. That’s about the best fuel a zombie company could ask for.
But now, the Fed is about to cut the zombies off…
It all comes down to the Fed’s “dual mandate.” It’s bound to “promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.”
Today, the “stable prices” part of that mandate is presenting the problem…
Prices aren’t so stable right now. In fact, inflation is near levels not seen since the early 1980s. And it’s getting to the point where it’s dangerous to the economy.
So the Fed needs to act. It has to raise rates to slow down inflation and stabilize prices. And like it or not, that means the Fed is about to go zombie hunting…
When rates rise, the cost of debt goes up – especially for high-risk zombies. And it gets worse for those companies… Zombies get trapped in a position where they can no longer “roll” their debt.
That’s the real zombie killer…
Zombie companies often “roll” their debt by pushing the due date later and continuing to make payments. They can keep doing that as long as rates remain low.
However, when rates rise, it’s possible that the new terms will no longer work for the zombies. In other words, the zombies won’t be able to afford their new loans.
Suddenly, the company is left with low income, high debt, and a big interest bill. When that happens, bankruptcy is the most likely outcome.
And folks, the Fed openly said it’s going to raise rates as soon as next month. That means it’s hunting zombies.
The bottom line is simple…
You don’t want to get caught in the middle as interest rates rise. Avoid investing in highly leveraged companies that don’t have the cash flow to support their borrowing habits.
Good investing,
Karina Kovalcik
