Do American Zombie Companies Fuel New Risks?

The number of “zombie” companies has sharply increased with one in five U.S. firms are now zombies. This is primarily due to the Covid-19 pandemic.

What are “zombies”?

Firms whose debt servicing costs are higher than their revenue/profits but are kept alive by relentless borrowing. Zombies provide 2.2 million jobs in the U.S. As long as the Fed (or other central banks) keeps rates low for a long time, unproductive firms remain alive. But ultimately it lowers long-run growth rate of the economy.

If a V-shaped recovery is nebulous, and a prolonged U-shaped recovery is more likely then moribund companies scarred by the pandemic will keep borrowing. Is the Fed and the Government interfering in the process of creative destruction? Some think so!

If the pace of the recovery is quick enough, corporate-bond buyers say plenty of hard-hit companies should be able to turn things around. But the question on the minds of investors and economists alike is: how long will the Fed be willing to support firms via its pledge to buy corporate debt if the recovery is slower to develop than expected?

“The government has done more than I could have imagined to allow businesses to access capital, and if the markets shut down again the government will do even more,” said Bill Zox, chief investment officer of fixed income at Diamond Hill Capital Management, which manages around $19.5 billion.

Cruise lines have borrowed more than $8 billion via the bond market in recent weeks, selling notes secured by everything from ships to islands. Airlines, for their part, have gotten more than $14 billion in new financing from banks and investors while the vast majority of flights remain grounded.

“We have entire industries that are going to be protracted long-term if not permanently disrupted because of this,” said Vicki Bryan, a veteran credit analyst who runs Bond Angle LLC. “The cruise industry is ripe for elimination of companies. It should logically renounce the weaker players but that’s not happening because we have dirt-cheap money that we’re willing to throw back into the market from the Fed.”

Beyond just lending them money, creditors are also waiving or loosening financial markers on existing debt, allowing companies that have seen revenue dry up stave off potential tumult.

Vail Resorts Inc., owner of the eponymous winter vacation destination, was granted a two-year reprieve on key debt covenants last month, paving the way for the company to raise $600 million with a new bond offering. Marriott, one of the world’s largest hotel chains, struck a similar agreement with lenders.

A representative for Vail said that the company’s bank covenant waiver provided additional flexibility given the short-term dislocation from Covid-19, and that it remains confident in the long-term outlook for both profit and cash flow.

Yet amid the waivers, lenders are extracting higher interest rates or other concessions. Norwegian Cruise Line Holdings Ltd., AMC Entertainment Holdings Inc. and Avis all paid double-digit yields to borrow in recent weeks. That could depress their capacity to make capital expenditures and adapt to shifting consumer tastes as the coronavirus changes how people spend money.

“Taken together with margin contraction and leverage that was already near record highs, you may end up with a corporate sector that has less capacity to invest in growth,” said Noel Hebert, director of credit research at Bloomberg Intelligence.

Some say as successful as the Fed has been boosting credit-market liquidity, the support is only temporary, and will result in a wave of distress when it steps back.

“There will be plenty” of debt defaults and bankruptcies when corporate borrowers start running out of cash in the months ahead, Howard Marks, co-chairman of Oaktree Capital Group, said in a Bloomberg interview. “There are large, highly levered companies and investment vehicles that the government and Fed rescue program is not likely to reach and take care of.”

Others see central-bank intervention keeping companies alive for much longer, crowding out investment and employment at healthy firms, similar to what occurred in Japan during the nation’s ‘lost decade’ of the 1990s, where the ‘zombie company’ term was first applied.

The repercussions may only become apparent years from now, according to Marc Zenner, a former co-head of corporate finance advisory at JPMorgan Chase & Co.

Will this cause another crisis? Or, will economies move like Japan in its decade of stagnation?

What do you think?

Stagnation

“Kicking the can down the road”

New crisis in the making

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References:

1. America’s Zombie Companies Are Multiplying and Fueling New Risks, Lisa Lee and Michael F David, May 19, 2020 (www.bloomberg.com)

2. Highly Indebted “Zombie” Companies Control More Than 2 Million U.S. Jobs, Jeff Cox, May 20, 2020 (www.cnbc.com)

3. “Zombie” Companies May Soon Represent 20% of U.S. Firms, Dion Rabouin, June 15, 2020 (www.axios.com)

“Why Nations Fail”

Source: Global Risk Insights

Daron Acemoglu of MIT and James Robinson of Harvard co-authored a book entitled as above. Their study of rise and fall of economies all over the world concludes that China is on course to reach about a third of U.S. per capita income by late 2020s and about 40% of that in the 2030s. It will be difficult to progress further, if China remains a “copycat” economy.

A good analogy is the Soviet Union in the middle of the 20^th century. Moving from agrarian into an industrial economy, it was one of the fastest growing economies. Then it ran out of steam in the 1970s. Malaysia similarly had remarkable growth in the 80s and 90s and then settled for a sedentary pace of 4-5% p.a., with no Covid-19.

Acemoglu calls them “extractive” economies run by a narrow political elite for their own benefit. Such economies hardly innovate because innovation means allowing new “champions” to emerge and outcompete existing power players. In China (or Malaysia) the economy is dominated by large state enterprises often controlled by elites or some political members of a ruling party (or coalition).

Malaysia, China or others like them can be innovative if political reforms and key institutions are strengthened to act independently. For example, a judiciary that acts fearlessly and competently will encourage innovation - knowing that intellectual property will be protected. Falsified research, malaise in standards, rampant copying, abuse of human rights, violation of basic universal values are all elements of a decline. Why did Rome fall? A steady deterioration of values; increase in corruption and intrigue; and, weakened institutions ensured its eventual demise. Not barbarians at the gates!

‘Black Lives Matter’ is a renewal for America. The Trump moral morass is now under a renewal reset. Campaign slogans work for a while but real change is needed.

That’s where Acemoglu and Robinson’s major thesis is – economic prosperity depends on inclusiveness of economic and political institutions. When people have a say in the decision-making, that is inclusiveness. When talent and creative ideas are rewarded, that is inclusiveness. When minorities feel they are part of a large tent, that is inclusiveness. In contrast, “extractive” institutions are those that extract wealth from the non-elite. Nations with a history of extractive institutions have not prospered – Congo, North Korea, Haiti, Somalia, Zimbabwe, Egypt, Pakistan, Myanmar and many others. They are poor because the ruling elite has organised society for their own benefit at the expense of the people.

The choice for the rich is whether it is taxation and redistribution or will the poor decide for renewal or revolution as the way forward. The rich have the incentive to propose a taxation rate that doesn’t provoke a revolution, while not losing too much of their benefits. So, democratization refers to a situation where the rich “willingly” increase monetary redistribution to the poor in order to avoid a revolution.

In short, authoritarian economies choke-off sustained, long-term growth and prosperity. Inclusiveness, equality and diversity enable societies to flourish and prosper. And institutions where strengthened provide the platform for this to take shape. This postulate has critics who cite technology, geography, productivity, leadership as other factors for nations to succeed. Whatever the case, we in Malaysia are at a critical stage in our development and leaders need to look at issues objectively rather than be coloured by lenses of race and religion.  

Reference:

1. Marshall Ingwerson, ‘Why Nations Fail’: Will this be China’s century? www.csmonitor.com

2. Ed Sappin, Five reasons China will fail to dominate in business, CNBC

3. Warren Bass, Book review: ‘Why Nations Fail,’ by Daron Acemoglu and James A. Robinson,   The Washington Post

4. Why Nations Fail, www.wikipedia.org

The Five Biggest Stocks on S&P 500

Apple, Microsoft, Alphabet,Amazon and Facebook — now make up 18% of the total market capitalization of the S&P 500, the highest percentage in history, according to Morgan Stanley.

"A ratio like this is unprecedented, including during the tech bubble," Mike Wilson, the bank's head of U.S. equity strategy, said in a note Sunday. "Capital concentration is following corporate inequality like never before."

Apple's weighting in the S&P 500 surpassed 4% in October, the sixth time the iPhone maker has crossed that threshold. But if history is any guide, it could be a ominous sign for the stock, according to Leuthold Group analyst Phil Segner.

He noted during the previous five times when Apple topped the 4% threshold, the stock underperformed the S&P 500 by nearly 9% on average in the next 12 months.

Going back to 1990, only five stocks — Apple, Microsoft,Generic Electric, Cisco Systems and Exxon Mobil — have claimed more than 4% of the S&P 500, and their leader status has typically been short-lived.  General Electric stayed the longest — 15 months — above the threshold, while Cisco only lasted a month.

Apple and Microsoft, which surged 86% and 55% in 2019, respectively, together accounted for nearly 15% of the S&P 500′s advance last year. No other stock even came close to their contribution.

The megacap stocks are leading the market again in the new year. In fact, the 50 largest stocks in the S&P 500 are up the most this year with an average gain of 1.22%, according to Bespoke Investment Group.

"The larger, the better so far in 2020," Paul Hickey, Bespoke's co-founder said. "Market cap has seemingly been the most important factor in terms of performance so far this year."

Bank of America highlighted the "rising correlation and concentration risks" in a recent note to clients, arguing a case can be made for active stock picking in other areas of the market away from the big players.

The 10 largest stocks in the S&P 500 and the Russell 1000 benchmarks now account for 23% and 21% of the total index market cap, respectively — the highest levels since the tech bubble, according to Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America.

As these tech giants' market caps ballooned to record highs, their income contribution to the broad market decreased in recent years, a red flag for the stock prices, Wilson of Morgan Stanley said.

"These companies will then need to deliver on the income side of the inequality divide or risk a sharp decline in price," he said.

Reference:

The five biggest stocks are dwarfing the rest of the stock market at an 'unprecedented' level, Yun Li, Jan 13 2020 (https://www.cnbc.com)

Marcus Aurelius’ Secrets to a Happy Life

Life is full of laughs and tears, surprises and disappointments. We cannot control what happens to us, but Marcus Aurelius said, we can control our reactions to the events. Your happiness always depends upon the quality of your thoughts.

Here are five of the most important insights on how to live a happy life from the writings of Marcus Aurelius:

Appreciate the shortness of life

“There is a limit to the time assigned to you and if you don’t use it to free yourself, it will be gone and will never return.”

True. We can always earn more money, but money can’t buy more time. The key lesson from Marcus Aurelius here is to learn to appreciate the little time we have and to start living our lives today. We often tell ourselves to start our plan tomorrow: workout, eat healthy, or sleep early. But are we actually starting tomorrow? Or tomorrow’s tomorrow? Understand the shortness of life and start living for today! When you focus on your plan, you will start loving your life.

Stop seeking the praise of other people

“It doesn’t matter how good a life you’ve led. There’ll still be people standing around the bed who will welcome the sad event.”

You can’t please every single person around you. Even when you are being sweet and kind, there are still people who dislike or disapprove of you. You don’t have to have the same thoughts or opinions as others. If there is someone that you really find uncomfortable with, leave them.

Negative emotions are a result of negative thinking

“Your ability to control your thoughts—treat it with respect. It’s all that protects your mind from false perceptions—false to your nature, and that of all rational beings.”

We are the one who give ourselves negative emotions. Different people may react differently to an identical situation. For example, the Movement Control Order. Some people think that the partial lockdown has completely ruined their lives. Economies are impacted so badly, and some may feel there is no tomorrow. Meanwhile, there are people who embrace the MCO. They believe that this is a good opportunity to spend time for themselves and with their loved ones. The negative emotions we experience are often just the result of how we interpret things.

Focus only on what you have control over and ignore the rest

“The cucumber is bitter? Then throw it out. There are brambles in the path? Then go around them. That’s all you need to know. Nothing more.”

There are only two things in this life we have control over: our thoughts and actions. That’s it. The rest is out of our hands. But, how often in life do we waste time and effort, complaining about things in which we simply have no influence over?

Seek to build your own character

“The mind in itself has no needs, except for those it creates.”

People love a big house or a big car. When you seek happiness in the form of material possessions, you will never find joy. “If you can’t stop prizing a lot of other things? Then you’ll never be free—free, independent, imperturbable. Because you’ll always be envious and jealous, afraid that people might come and take it all away from you.”

In short, it is up to you to decide whether you want a happy life: how you see your life and how you live your life. Understand yourself: what you like or dislike and leave all the “toxic” persons or emotions behind. If something you can’t control has happened? Forget about it!

Reference:

Do you agree?

Yes

No

 

pollcode.com free polls

1. 5 Key Insights For A Happy Life From Marcus Aurelius’ Meditations https://www.dumblittleman.com/

2. Carolyn Gregoire, Marcus Aurelius and the Key to Happiness http://www.dailygood.org/

Crash 2020: Where's the Bottom?

The most respected valuation methods available suggest the current market downturn could very likely end with the S&P-500 in the range of 1500 to 2000.  The equivalent Dow values would be around 14,000 to 18,000.

However, that range would be the long term "median" or "average" value.  Looking at previous downturns such as the 2007-2009 crash, the S&P500 could overshoot down as low as 1130 (or Dow at 12,000) to reach a bottom before rising again.

The economy is in a worse recession than the 2007-2012 with unemployment rising to 15% and taking a long time to recover.

Market downturns can take over three years to go from top to bottom with lots of 'rallies' in between.  The "Housing Bubble" crash of 2007-2009 took a relatively short 17 months with at least 6 rallies along the way - 3 rallies of more than a month.

The U.S. markets are in a "rally" retracing 50% of the previous drop.  That is a standard type of rally in a bear market – 50% “retracement” is the norm.  While nothing is certain, it is hard to believe it will persist with the widespread economic devastation that is already starting to manifest. 

According to the President of the Wells-Fargo Investment Institute, since 1929, there have been 13 "waterfall" market crashes like the one in March. Each one was followed by a 50% "rally" (i.e., a retracement of lost value).  Every single one of those rallies failed and the downward trend resumed. 

One estimate of market value is the Shiller CAPE Index.  Dr. Robert Shiller of Yale University won the 2013 Nobel Prize in Economics for his work in 'Asset Valuation'. The Shiller CAPE ratio is currently (18/6) at 29.1 but the historical mean is at 17.1.  For the ratio to get to its historic mean it would need to drop about 41% from current levels.  Further, the CAPE ratio overshoots both ways.  In 2000 it overshot to the high side to hit 44, and in 1982 it overshot to the low at around 7.

With the S&P 500 currently at 3113, to achieve the median Shiller P/E value, the market would need to drop to 1829 to reach the median value of 17.1.

Warren Buffett popularized a way of determining if the broader stock market is over- or under-valued using the TMC of all stocks divided by the GDP (Gross Domestic Product = all goods and services in the US economy).

Buffett Indicator = TMC/GDP

The chart below shows GDP in green, Total Market Cap in blue.  When the TMC is above the GDP the stock market is expensive by Buffet's criterion.

https://www.gurufocus.com/stock-market-valuations.php

https://www.gurufocus.com/stock-market-valuations.php

The market has been mostly undervalued or overvalued according to Buffett's indicator.  Please note that by this criterion, the market was extraordinarily overvalued in January 2020 at 150%, even more overvalued than the 140% reached in the Dot-Com Bubble of 2000. 

Nothing is certain, especially with the CoVid-19 virus mutating, potential vaccines, and other unknowns affecting things.  It does seem that the market was unusually over-valued in 2018-2019 and was overdue for a "correction".  That "correction" seems to have a while to go both in time and distance.

[Nothing suggested here is investment advice or a recommendation to buy or sell securities of any form in any markets]

Reference:

Stock Market Collapse, An Avalanche Waiting to Happen, (http://meetingthetwain.blogspot.com/2020/04/crash-2020-wheres-bottom.html)

Economic Impact of the India-China Conflict

The Week

China and the U.S. are the two largest trading partners of India. For the period April 2019 to February 2020, China accounted for 11.8 per cent (USD70b) of India’s imports. India’s exports to China was a mere 3%. India’s trade deficit with China stood at USD3.3 billion in February. Overall trade deficit was close to USD10 billion (in China’s favour). Trade reduced significantly because of the pandemic and rising tensions.

India imports engineering goods, electronics, pharmaceuticals and automobile components. India’s exports to China include organic chemical, ores, slag and ash, mineral oils, mineral fuels and other industry products.

The total amount of current and planned investments by China into India has crossed USD26 billion (according to Brookings report). Alibaba has invested in Indian e-commerce company Snapdeal, digital wallet Paytm and food delivery platform Zomato. China’s Xiaomi leads India’s smartphone market with 30 per cent market share followed by Vivo, Samsung, Realme and Oppo. Sales by Chinese smartphone brands totalled more than USD16 billion in 2019. Xiaomi manufactures 95% of its phones it sells in India locally.

Although India will be impacted economically, China too will suffer with a boycott of its products. India will now cancel several pending public works contracts with Chinese groups. The state-owned telecoms company, BSNL, has been told to find non-Chinese alternatives for network upgrade. Many start-ups will be caught in the crossfire.

Regardless of who started this, China may have just delivered India to the U.S. A non-aligned country like India will find it hard not to seek partners to counter-balance Chinese military power.

China has trade or territorial issues with the U.S., Australia, U.K., Canada, Japan, Vietnam, Philippines, Indonesia, Malaysia and Brunei. Why? From a political standpoint this is a playbook from the past. When the CCP faces mounting discontent from the people, for example mishandling of the pandemic in this case, it turns the problem into an external issue. That appeals to nationalistic jingoism. It is the same with the U.S. in some ways. China-bashing was made popular by the extreme right (in the U.S.) and assiduously followed by Trump – forget his “love” for Xi.

Could China have acted differently?

There was empathy for the people of China with the “Wuhan” virus. It was an opportunity for the CCP to build stronger relationships on trade, medical supplies and research with neighbours. And this was especially so with the U.S. marching on a Trumpian tune of “Me” only. That has been lost with skirmishes and aggression in the Himalayas and the South China Sea.

The major casualty in all this is Trust. It will take a long-time for that to be restored. Meanwhile, we can pray for de-escalation of the India-China border situation. It is not in the interest of either nation to escalate present tensions and destroy each other for the vain glory of any leader.

Reference:

1. India rethinks strategic ties following border clashed with China, Financial Times, 18 June 2020, by various reporters (Amy Kazmin, Tom Mitchell and Katrina Manson)

2. Economic impact of India-China conflict: Why there won’t be just one loser, The Week, 18 June 2020, by Web Desk

3. India-China clash: An extraordinary escalation ‘with rocks and clubs’, BBC News, 16 June 2020, Soutik Biswas

The Cost of Racial Discrimination

The killing of George Floyd has led to protests across the U.S. and other parts of the world. Modern racism as examined by Mangai Balasegaram (Star, Sunday 14 June 2020), is skin colour based, unlike the Romans of old!

The narrative that dark-skinned humans are inferior was probably propagated after abolition of slavery in the British colonies in 1833/34 and the U.S. in 1865. Slaves were “stupid” and “lazy” just like natives who need to be colonised. So ideas like white supremacy persist. Systemic racism traps people of colour making social mobility difficult.

It is alive in the U.S., as recent events testify, it is alive in England, and many other parts of the world. We are no exception. In Malaysia, people of Indian origin account for one in four deaths in custody. And Indians make up on 7% of the population. N Dharmendran, Kugan and others have died in custody. Many are displaced people who end up in crime and gangs.

How did it come to this? One may examine history and we have indentured labour coming from India to Malaysia, close to 200 years ago. Who did this? The British of course! After slavery ended, plantation owners looked to India for replacements. The indentured workers were desperate, impoverished peasants burdened by British taxes who had little choice but to work in plantations of Malaya, Fiji, Mauritius, or the Caribbean. They were treated as slaves – pay withheld, poor sanitation, shoddy housing, no education and violence from British raj.

In the 1980s, when some plantations closed or were fragmented (for housing projects), more than 300,000 Indians were evicted. They had no skill (other than tapping), no education and no housing. Now, 40% of the Indians in Malaysia are in the B40 group. There is no poverty eradication programme, except those that are on paper or blueprints. What does this group need? Education, employment, entrepreneurship and health (3Es+H). Many governments have promised solutions before an election, but quickly forgotten until the next election. Meanwhile, they lead gangs or drug-related ventures.

Of course, there is other institutionalised discrimination that needs to be costed.

What is the cost?

A study in Australia by Dr Amanuel Elias puts the figure at AUD44.9 billion annually for the Australian experience. He used number of healthy years of life lost or Disability Adjusted Life Years (“DALYs”) into a monetary value. One DALY is one year of healthy life. For Australia, the cost was 285,228 DALYs every year. Then you are able to scope the cost of anti-discrimination intervention. The recent pandemic has manifested subtle and institutional discrimination in Australia. One in five Australians experience racial discrimination.

Perhaps someone could do a similar study in Malaysia?

References:

1. The Deep Historical Roots of Racism, Mangai Balasegaram, The Star, 14 June 2020

2. The Cost of Racial Discrimination, Dr Amanuel Elias, Researcher, Alfred Deakin Institute for Citizenship and Globalisation

Will Economic Ghosts Block Post-Covid Recovery?

Prof. Jomo K. Sundaram writing in Business Focus on 10 June 2020 suggested that “governments all over the world (will) struggle to revive their economies.... (with) neoliberal naysayers already warning against needed deficit financing....”

Deficit financing options have changed little since first legitimised by Keynes in the 1930s. Prof. Jomo argues that government debt exceeding twice national income like Japan is not a problem if it is held by locals and issued in the local currency. Second, price controls on extracted natural resources may enable government to secure resource rents to augment revenue. Third, the use of QEs is giving a boost to modern monetary theory. Finally, an overvalued exchange rate favours the elite and may even be a cause for national pride. This is a temporary solution favouring consumers over producers and importers over exporters. East Asian economies have done the opposite to their betterment.

Deficit spending in some respects was to meet demands of interest groups for higher wages, cheap housing, public healthcare and free schooling. Macroeconomic populism was used to explain increase in government spending and budgetary deficits. However, neoliberal commentators are warning against deficit financing and insisting dogmatically minimal budget shortfalls and/or balanced budgets.

Following neoliberal policies have widened wealth and income disparities around the world. In the U.S. three decades of neoliberal economic policies has led to widest gap between the rich and the poor. The top 20% in the U.S. receive about 50% of the income and the lowest 20% receive a mere 3.4% of the income. The top 1% own 40% of the wealth.

The Covid-19 crisis presents an opportunity for reform and exorcising the ghosts of the past. But will the political masters have the moral courage to do the “right thing”?

What’s for Malaysia?

There are ample areas for reform including suspending affirmative policies for a period; minimising government intervention and bureaucratic procedures; developing new areas to focus – renewables and digitalisation; and creating R&D clusters for resource-based, medical and other key areas where Malaysia may have a strong competitive advantage. That requires courage, perseverance and fortitude.

References:

1. Jomo K. Sundaram, Economic ghosts block post-lockdown recovery, Focus Malaysia, 10 June 2020

2. Sharon Beder, Neoliberalism and global financial crisis, University of Wollongong, Australia

What Does The Buffett Indicator and Shiller P/E Tell Us?

The Buffett Indicator simply compares the total market capitalisation of U.S. stock market to U.S. gross domestic product (GDP). In a nutshell, it measures the stock market to the economy. The underlying basis is that the economy or economic growth drives corporate profits. So stock prices cannot outpace economic growth indefinitely.

The U.S. stock market is now 150% of the economy, close to the highest in history. It is probably higher as Q2 shrinkage of the economy is not accounted for. During the 2008 meltdown, the Buffett indicator dropped to about 50%. It is perhaps too much to read into a single indicator.

Prof. Robert Shiller of Yale created the Schiller P/E as a measure of the market’s valuation. The Schiller P/E is a more reasonable market valuation indicator than the P/E ratio. Why? It eliminates fluctuations of the ratio due to variation of profit margins during business cycles.

The regular P/E uses the ratio of the S&P 500 index over the trailing 12-month earnings of S&P 500 companies. It is artificially low during economic expansions and companies have better profit margins and earnings. The converse is true in recessions.

Both indicators (Buffett and Schiller) are useful for investors to decide when they should explore investing in a market. Currently, with the U.S. economy in a tailspin, U.S. unemployment at above 13%, Buffett indicator above 150 and Shiller at 28, it is not exactly time to invest in the U.S. market.

References:

1. Shiller P/E – A Better Measurement of Market Valuation, Friday, 12 June 2020 (www.gurufocus.com/shiller-PE.php)

2. What the Buffett Indicator Tells Us About the Highest Market Valuation Ever, Charles Sizemore, 11 June 2020 (www.moneyandmarkets.com)