Boosted immunity Monday. For a second Monday in a row, stocks rallied on positive virus news. Moderna’s announcement that their vaccine had a 94.5% efficacy rate pushed the Dow and Russell to new highs as the value rally continues on hopes of recovery
N O T E W O R T H Y
“2022 could be a big game changer…” Said the online hotel search application CFO in an interview. Wow! What a telling statement. First of all… 2022? That is at least 13 months from now, assuming all the game changing comes in January of that year. The CFO also embellished his projection with a “could”! Talk about conviction. Perhaps I am being too harsh. After all, we are in the midst of a crisis, the likes of which we haven’t seen in modern times. I purposely avoided the now most overused word of 2020: “unprecedented”. I think we all know that the virus will be contained at some point and that the economy will get back on its feet and bring great prosperity. Happy days WILL be here again, but exactly when is anyone’s guess. More importantly, what will those happy days look like? Will people still pile into 10-story-high cruise ships and line up for midnight buffets? Will traveling road warriors rack up millions of airline miles a year, zig-zagging the country from Marriott to Marriott on the company card? Will shoppers squeeze into large high-rent department stores to browse the latest fashions for inspiration? Will companies maintain Class-A office space in tony, high-rent cities when workers have proven to be equally productive working from their homes? We have all asked ourselves these questions in the past several months and though we may be just getting a first glimpse at that light at the end of the tunnel with the recent vaccine announcements, we still don’t have answers to any of those pressing questions. Let’s bring this back to the investing world and talk about zombies. “What! Did he just say zombies?” Don’t worry this not an homage piece on George Romero (creator of the 1068 cult classic Night of the Living Dead), but rather an important concept in value investing. The concept of zombie companies first sprang onto the scene in the 1990s in response to the large number of Japanese industrial giants that were kept on life support with bank debt after the 1980s asset bubble collapsed. A zombie company is one which is able to only generate enough cash to pay its debt service but unable to retire its debt. This leaves companies in a weakened position, unable to invest in growing or evolving their businesses. In Japan, zombie companies are said to have led to what was referred to as the “lost decade” of the 90’s. In the US, the pandemic has wrought financial havoc across all sectors. Particularly hard-hit were those that rely heavily on a steady flow of in-person consumers. Think: movie theaters, malls, hotels, airlines, cruise lines, etc. In these past few weeks, we have witnessed investors turn their focus away from pandemic-favorite growth stocks and onto heavily beaten down value stocks. At a high level, given the positive news on the vaccine front, it makes sense that investors look to jump into the beaten down stocks which should, in theory, rally once the economy gets back to pre-pandemic levels. As a result, stocks of those beaten down companies have, in fact, rallied as a result of the rotation. The question that investors should be asking themselves is how long will it take those companies to get back to their former values, or if they even ever will. Sure, many will, but some of them have taken on significant debt burdens in order to survive through the lean months of the lockdowns. Remember those zombies? Boeing, Carnival, Exxon Mobile, Delta, and Macy’s just joined the list. A list which has added nearly 200 other companies since the beginning of the pandemic. In fact, almost 20% of the 3000 largest companies are now zombies, having added nearly $1 trillion in new debt, bringing the total indebtedness of the group to roughly $1.4%, a record which far exceeds the $500 billion peak from the Financial Crisis. To be clear, some of them will be able to drop the status, while others will not make it, still others will be doomed to remain zombies forever, never to return to their former, vibrant, value creating selves. When looking for value, investors need to be prudent in order to avoid getting that fatal bite.
Stocks rallied sharply yesterday in response to Moderna’s very positive results from their late-stage vaccine trials. The S&P500 rose by +1.16%, the Dow Jones climbed by +1.6% to a new high with 30,00 in its sights, the Russell 2000 Index jumped by +2.37% to another new high, and the Nasdaq Composite added +0.8-%. Bonds inched up and 10-year treasury yields added +1 basis point to 0.90%
– Retail Sales (Oct) are expected to have grown by +0.5%, slower than last month’s +1.9% advance.
– Industrial Production (Oct) may have grown by +1.0% after slipping by -0.6% in September.
– Fed Chairman Jerome Powell will speak today in addition to several other Fed officials.
– This morning, Home Depot. Kohl’s and Walmart beat estimates, while Aramark missed.
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