03-Sep-21 Macro

Dawn of the not-so-dead

U.S. delinquencies have been surprisingly low throughout the pandemic. Do not expect them to spike any time soon.

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It is one of the oldest rules of thumb in economic forecasting. When economic downturns hit, personal and corporate bankruptcies spike. Indeed, insolvency through ill luck as much as moral vice was a familiar theme in Victorian literature, long before economists had much to say about business cycles. What then, should investors make of the surprisingly low U.S. delinquencies throughout the pandemic?

Covid-19 administered the sharpest shock to both the U.S. and the global economy since reliable data began to be collected. Not that you could tell from U.S. insolvency statistics, as our Chart of the Week shows. The number of Chapter 11 court filings by businesses in trouble has remained subdued, as have broader default rates (which are mostly driven by loans to households). For households, explanations are straightforward. After all, the Covid recession was unusual not just in terms of a sharp, but short, downturn, followed by an equally swift recovery. The later was made possible by an unprecedented amount of fiscal and monetary stimulus, including direct payments to households.

Surprisingly few U.S. insolvencies

20210903_CotW_US delinquencies_CHART_EN.png

Sources: U.S. Federal Reserve, Administrative Office of U.S. Courts, Bloomberg Finance L.P., DWS Investment GmbH as of 9/1/21

Companies surviving as walking dead can depress productivity and growth.

The low levels of corporate insolvency filings are more counterintuitive and potentially troubling. Early on during the pandemic, there were wide-spread and not altogether unjustified fears that indiscriminate rescues could risk zombification[1]. Creative destruction is painful, but a core part of how changes happen in market economies. Companies surviving as walking dead can depress productivity and growth. However, there are also numerous examples of how sitting out a downturn can pay lasting dividends for both countries and companies. For example, Japanese chipmakers finally succeeded in breaking U.S. dominance in memory chips from the mid-1970s onwards. Their secret? Maintaining their work force and production capacity during the recession that followed the first oil shock, unlike most U.S. semiconductor firms.[2] More recent examples include European furlough schemes during the great financial crisis.

Overall, we only expect a default rate of 1.5% for U.S. high-yield bonds during the next twelve months. Given how tight spreads are, though, we will still be scanning the statistics for signs of trouble beyond that.

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1. Colloquial term for keeping companies alive that under normal circumstances would be unable to continue to operate

2. Reid, T. (1986), The chip: how two Americans invented the microchip and launched a revolution, Touchstone, p. 222

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