WeWork, the office-sharing company once valued at $47 billion, filed for Chapter 11 bankruptcy protection last week. It made headlines, but it is all the bankruptcies you haven’t heard about that are a bigger threat to the U.S. economy.
There is a lot of good economic news out there. The U.S. economy recently printed a 4.9 percent growth rate for Gross Domestic Product. The unemployment rate remains low. Artificial intelligence promises improved corporate productivity in the years to come. And company profits are set to grow after several quarters of year-over-year declines.
It is little wonder that I remain invested in the U.S. equity markets. However, that doesn’t mean that I am a Pollyanna; there will come a time when I will focus even more on capital preservation. So, I look for clues that things are getting risky.
The whole of the U.S. economy is humming along. The thing about that is recessions don’t bring down the entire economy at once. Broad recessions happen after certain “pillars” break down and, eventually, everything collapses.
The Federal Reserve has raised rates by over five percentage points since March 2022. The Fed’s last hike was likely in the July 2023 meeting. The overall economy may not begin to feel the total weight of those higher rates for nearly a year after the Fed’s last hike. We won’t know the timing for sure until it happens. But we can inspect those pillars to see if any are crumbling. And some are. For instance, small companies in the U.S. are feeling the pain of those higher interest rates.
There were 516 U.S. corporate bankruptcies in 2023, compared to 372 in all of 2022 and 406 in 2021.
The 2023 run rate of year-to-date bankruptcies is 688. It is not a stretch to believe that number will be reached. The Fed’s Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) found that most banks “reported having tightened standards or terms on commercial and industrial (C & I) loans,” making it more difficult for companies to secure financing to maintain necessary cash flow.
The chart below, from Bespoke, suggests that tougher lending standards for C & I loans are consistent with previous periods of recession.
Hitting 688 bankruptcies would be more than 2020, when pandemic-era government-mandated shutdowns caused permanent closures. And it would be more than 2019 when I argued that there would be a recession in 2020 (I did not expect COVID-19, but I felt there would have been a downturn in 2020 even without the pandemic).
Of those 516 bankruptcies that have occurred this year, the bulk of them were small companies (at least relative to the companies that comprise the S&P 500 index). There were some notable large companies (e.g., Yellow Corp., with 30,000 employees; Diebold Holdings, with 23,000; Silicon Valley Bank, with 8,553; and SmileDirectClub, with 4,850 employees), but these recent bankruptcies have primarily been a small-business story.
The weakness in small companies is notable and perhaps predictable. Smaller businesses are traditionally those most damaged by higher interest rates. This is meaningful because companies with 500 or fewer employees account for about 43 percent of the Gross Domestic Product, according to the U.S. Chamber of Commerce. And 63 percent of new jobs were created by companies with fewer than 100 employees between 1995 and 2021.
These smaller companies are beginning to feel a cash crunch due to a higher cost of capital. That crunch is coming at a time when banks are beginning to restrict lending, choking off much-needed cash reserves. There is no light at the end of the tunnel. The Federal Reserve reports that banks expect to “further tighten standards on all loan categories.”
The labor market is also beginning to experience the effect of higher interest rates. The most recent labor market report revealed that a not unhealthy 150,000 jobs were created in October 2023. And the unemployment rate came in at a solid 3.9 percent. However, that 3.9 percent is up from 3.4 percent earlier this year. This has been the largest uptick in unemployment since the Great Financial Crisis of 2008–2009. The trend is inching toward more weakness.
The end of the U.S. economic expansion may not be nigh, but I will keep a look out if it is getting closer.
Allen Harris is the owner of Berkshire Money Management in Dalton, Mass., managing more than $700 million of investments. Unless specifically identified as original research or data gathering, some or all of the data cited is attributable to third-party sources. Unless stated otherwise, any mention of specific securities or investments is for illustrative purposes only. Advisor’s clients may or may not hold the securities discussed in their portfolios. Advisor makes no representations that any of the securities discussed have been or will be profitable. Full disclosures here. Direct inquiries to Allen at AHarris@BerkshireMM.com.
