‘Zombie’ companies already make up 11.5% of U.S. listed stocks

About 11.5% of listed U.S. stocks already belong to a large network of “zombie” companies that have consistently earned less than they owe in interest costs, according to a tally from Glenmede.

While that might not sound ideal, higher bond yields or a recession could make a potentially ugly situation for investors even worse.

“The combination of rising borrowing costs and heightened recession risks could begin to tip zombie companies into bankruptcy,” a team led by Jason Pride, chief of investment strategy and research at Glenmede, wrote in a Tuesday client note.

Stocks, unlike bonds, often are at risk of seeing their entire value wiped out if a company files for bankruptcy. Recessions also tend to shake out smaller and weaker companies with high debt loads, in part because funding from Wall Street can dry up.

The Glenmede strategy team arrived at their zombie figure by looking at the share of companies in the Russell 3000 index
whose earnings before interest, taxes, depreciation and amortization didn’t meet their interest costs in the past three years.

Rise of the zombie companies? Higher borrowing costs or a recession could tip more into bankruptcy.

Glenmede, FactSet, Bank for International Settlements

While off peak levels in the wake of the pandemic, the chart suggests an elevated risk of public U.S. companies vulnerable to collapse.

The Russell 3000 index tracks shares of the largest 3,000 publicly traded companies, weighted by market capitalization, making it a proxy for the U.S. stock market, whereas the S&P 500 index
tracks the biggest 500 companies and the Dow Jones Industrial Average
tracks 30 stocks.

Higher bond yields can ratchet up interest costs for companies that need to borrow or refinance maturing debt. The benchmark 10-year Treasury yield
has now climbed for six straight months, closing out October at 4.874% and easing back from a brief jolt above 5%.

“All else equal, higher yields on Treasuries put pressure on equity markets,
as future cash flows used to determine fair value are discounted at higher rates,” the Glenmede team wrote.

Yields in the roughly $1.5 trillion high-yield, or “junk bond,” market were last pegged near 9.4%, according to the ICE BofA US High Yield index, among the highest since 2009.

Yet the biggest junk-bond ETF, the iShares iBoxx $ High Yield Corporate Bond ETF
was off only 1.4% on the year through Tuesday, according to FactSet.

Part of the resilience could be tied to the U.S. economy, which has continued to grow despite the Federal Reserve’s aggressive pace of rate hikes since last year.

Also, while 11.5% of the Russell 3000 index was pegged as zombies, the group accounts for only 2.2% of the total value of the stock market, since many were small-cap companies, according to Glenmede.

Furthermore, not all zombies automatically look like an imminent risk, the Glenmede team said, because it folds in companies still finding a market for their products or services. It also can include small biotechnology and technology companies, which tend to follow a “proof of concept, then monetize” business model, they said.

Stocks ended higher Tuesday, but with the Dow Jones Industrial Average
S&P 500 index
and Nasdaq Composite Index
booking three straight months of declines, according to Dow Jones Market Data.

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