Optimism and debt have become drugs and we’re all addicted
This article aims to unpack reality and show why rampant optimism threatens investors, businesses and prospects for building wealth.
So where does all this optimism come from?
The latest news is that the forecast of recession might not be as bad as everyone feared.
Inflation across many countries is slowing sooner than expected, energy prices are dropping, unemployment estimates have been lowered, and interest rates seem to be near their peak.
This hopeful news has done wonders for investors confidence. In February the British FTSE 100 breached 8,000 points for the first time in history although it has fluctuated since then but optimism is still reflected in the figures. This may be a return to the bull market with investors happily piling into the stock market.
Business owners are also optimistic, with many reporting increased sales, increased profits and forward guidance is also positive.
We are however making a grave mistake by ignoring the elephant in the room, the debt bubble. As of last June, the world’s total debt amounted to $300 trillion, 349% of world GDP.
Let that sink in. This elephant is 3x bigger than the entire world.
We would like to think we learned our lesson after the 2008/9 Great Financial Crisis but if anything, reckless monetary policy has flooded the world with cash. This in turn causes inflation.
So have we sewen the seeds of a bubble that we don’t want to acknowledge?
Debt ratios have exploded over the last two decades which in turn has established a large number of ‘zombie’ companies that cannot grow because profits and indeed any surplus cash is used to service debt.
According to think tank, Onward, 1-4% of companies have gone into a “zombified” state since the start of the pandemic and this percentage is increasing, taking the current total percentage of “Zombie companies” to higher than 20%. A recent Red Flag Alert published by Begbies Traynor for Q4 2022 reported that 610,405 companies in UK are in critical corporate financial distress.
This problem is not going to go away. Debt needs to be repaid at some point. What isn’t clear is how the debt bubble will be resolved. Some believe it will be a soft landing while others think it will burst and be far worse than 2008/9.
Despite the doomsters, failure this year of three of the four largest banks in history to go bust didn’t burst the bubble.
Hard data about the amount of money in the system following stimulus and monetary policy is somewhat boring and difficult to analyse, let alone comprehend. As is how it impacts on markets and the economy where often stock markets rise when the economy is in decline.
Reality is also being confused by soft data that plucks recent good news being used to justify optimism. The CPI is coming down despite prices going up. We have low unemployment figures despite high profile insolvencies and layoff announcements.
Is the market optimism based on hard data or soft metrics? We will all continue to pluck out those facts that we want to see, irrespective of reality. Truth has become a philosophical construct.
Many pundits anticipated a huge correction with lots of insolvencies after the Great Financial Crisis in 2007/8. Whilst company insolvencies did increase to a peak of 24,035 in 2009, the wall of work never materialised. References to ‘extend and pretend’, ‘time to pay’ and ‘kicking the can down the road’ were used to justify whey the pundits got it wrong then.
As for now, “those that fail to learn from history are doomed to repeat it.” Winston Churchill
So here we are 14 years later, with the same messages albeit this time with many more Zombie companies and higher interest rates. But is it déjà vu? What has changed?
This is not intended to predict the future but instead point out some tough realities we all need to face.
No one wants to see a lot of insolvencies but the fact is, like in 2009 a lot of companies cannot justify their existence. Despite this most Zombie companies are unlikely to be forced into a formal insolvency procedure and instead be propped up, like they were in 2009. Lenders do not want to write off their debts, preferring to live in the hope that they will be repaid. At least this will prop up their own balance sheets.
Those companies that are drowning in debt are likely to pursue the same policies that they and their creditors have adopted for years: ‘denial’, it worked then so why not now?
However, businesses with a future should be proactive, especially if they want to embrace opportunities and invest in growth. They should aim to significantly reduce their debt so they can invest in sustainable and profitable activities. They should recognise that after the recovery loan scheme ends, loans will be difficult to come by. They might also recognise that restructuring their debts may be the only way of reducing their debt.
Despite any argument about restructuring debt, I remain doubtful that much has changed. The restructuring of debt didn’t happen after the Great Financial Crisis and I doubt it will happen this time. Even though debt is that much greater. Unravelling the debt bubble may be much further off than realists believe.
Just like any drug, weaning ourselves off of optimism is painful. But if we care about our financial health, the sooner we can get rid of debt the better. Until then we will continue to take another drug, ‘denial’, and hope the problem will go away. As for reality that is for another day.