Economic Brake Lights

Sunday, November 4, 2018
By Paul Martin

By: John Mauldin
Sunday, 4 November 2018

But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to either ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren’t certain that you understand and can value your business far better than Mr. Market, you don’t belong in the game. As they say in poker, “If you’ve been in the game 30 minutes and you don’t know who the patsy is, you’re the patsy.”

Warren Buffett (b. 1930), 1987 Berkshire Hathaway Annual Report

Those who do not learn from history are doomed to repeat its mistakes.

—George Santayana (1863–1952), Spanish-American philosopher

Those who don’t study history are doomed to repeat it. Yet those who do study history are doomed to stand by helplessly while everyone else repeats it.

—Tom Toro (b. 1982), American cartoonist for The New Yorker

All good things come to an end, even economic growth cycles. The present one is getting long in the tooth. While it doesn’t have to end now, it will end eventually. Signs increasingly suggest we are approaching that point.

Whenever it happens, the next downturn will hit millions who still haven’t recovered from the last recession, millions more who did recover but forgot how bad it was, and millions more who reached adulthood during the boom. They saw it as children or teens but didn’t feel the full impact. Now, with their own jobs and families, they will.

Again, there’s no doubt—none, zero, zip—this will happen. The main question is when. Just a few weeks ago, I had hopes we could postpone it possibly even beyond the 2020 elections. It could still happen, but a barrage of data in the last few weeks suggest this may be more hope than reality. And as I constantly remind you, hope is not a strategy.

Last week (and indeed for the last year), I talked about our growing debt problem and how it could trigger a crisis. Excessive leverage may light the fuse, but the real problems are deeper. A new report, just out this week, highlighted an important one.

Zombies and Unicorns
Debt can be useful when used wisely and wisdom begins with being able to repay it. So, if you have a debt-financed business, for example, you should have enough steady revenue to cover your other expenses and the interest on your debt—with a plan to reduce that debt. If you can’t, something is wrong.

It turns out this is far more common than most of us think. A new Bank for International Settlements study examined a database of 32,000 listed companies in 14 advanced economies to identify “zombie” businesses. By their broad definition, a company is a zombie if it is…

at least 10 years old, and
its interest coverage ratio has been below 1.0 for three consecutive years.
That’s a low bar… yet 12% of the public companies they examined couldn’t pass it.

BIS doesn’t identify the companies by name. I suspect they are probably separate from the “unicorns” we hear about, which are mostly equity-financed by hopeful venture capitalists. In theory, bankers and bond buyers should be more risk-averse than VC investors, but that does not appear to be the case. Thousands of companies are going years with little prospect of repaying their debts, yet for whatever reason, the lenders see no need to stop lending to them, much less foreclose.

The Rest…HERE

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