Big Tech Is in a Perilous Moment. The Stocks Are Unstoppable.

By Eric J. Savitz and Max A. Cherney

Illustration by Nicolas Ortega


Over three days in late July, America’s tech giants put on an impressive show. 

Apple, Microsoft, Alphabet, Amazon.com, and Facebook had thrived in the pandemic, and their latest earnings reports hammered home the point. 

The five companies generated a combined $332 billion in revenue from April to June, up 36% from a year earlier. 

All of their profits were better than expected. The twist is that all of their stocks, save for Alphabet’s, sold off on the news.

The negative reaction reflects the paradox surrounding America’s Big Tech complex. 

Their products are being used more than ever, just as the companies have become increasingly disliked. 

Regulators and lawmakers—cheered on by a bipartisan mix of constituents—are scrutinizing each business and threatening significant actions to curtail their power. 

Evercore ISI analyst Mark Mahaney estimates that the regulatory scrutiny has already created a 10% drag on large tech stocks.

After thriving during the pandemic, tech companies are facing the challenges posed by a rebounding economy, as businesses and consumers potentially return to old, more analog habits.

Big Tech has hit a perilous moment. 

It won’t last. 

The five megacaps still have the best business models on the planet, and their stocks look relatively cheap. 

Investors should own them all, even if the regulatory headwinds take a while to abate. (See sidebar, “The White House Wants to Reign in Big Tech. Here’s How.”)

Taken together, the five tech giants—the largest companies in the U.S. stock market by a wide margin—offer a way to invest in the global economy’s most important trends: digital transformation and cloud computing, and the future of communication, entertainment, commerce, and work.

The cloud alone could power the growth of Microsoft (ticker: MSFT), Amazon (AMZN), and Alphabet (GOOGL) from here.

“Cloud is the reason I own all three of them,” says Walter Price, who runs the tech investment team at mutual fund company Allianz Global Investors. 

“The world’s enterprises are shifting computing to the cloud. 

This will be an annuity that lasts for decades. 

They can sell so many more things to their customers over time.”

Price, who has been running money at Allianz for close to five decades, sees a precedent in IBM (IBM), which came to dominate tech spending in the era of mainframe computing.

The old saying was that you don’t get fired for buying IBM.

Now, the saying applies to Microsoft, Price says. 

IBM’s recipe was selling more software and more services to more customers. 

Each of the Big Tech companies are following the same playbook.

There are near-term challenges, to be sure. 

A postpandemic hangover looks the most obvious at Amazon, where e-commerce is growing more slowly than in the past. 

Apple’s (AAPL) quarantine-fueled hardware boom has slowed. 

And all of Big Tech’s hardware arms are feeling the effects of component shortages and skyrocketing shipping costs. 

Apple has said that iPhone production could be crimped by parts shortages.

Another worry: Big Tech’s dominance has some investors seeing a peak in valuations. 

Apple, which leads the pack with a $2.4 trillion market value; Microsoft ($2.2 trillion); Alphabet ($1.8 trillion); Amazon ($1.6 trillion); and Facebook ($1 trillion) now account for 23.3% of the S&P 500 index’s value.

Then again, skeptics have spent years waiting for the law of large numbers to kick in. 

At the end of 2019, the Big Tech companies were about 18% of the S&P 500. 

Since then, each of the stocks has gained at least 70%.

Big Tech is eating the stock market, but technology is doing the same to the rest of the world—and the five megacaps remain the best way to play the trend.

Nonetheless, the regulatory overhang is real, even if there are signs that the risks have been priced in. 

That was one takeaway from a relief rally of 4% in Facebook (FB) stock in June after an antitrust lawsuit from the Federal Trade Commission was thrown out by a federal judge. 

(The FTC filed an amended version of the lawsuit on Thursday.)

Tech regulation is gaining steam in Washington, but the courts could hold back the most aggressive efforts. 

And some investors think that the worst-case scenario—forced breakups—could actually unlock value to the benefit of shareholders.

The long-term business trends offset the regulatory risks. 

Speedy 5G mobile networks are still rolling out, for instance, which will drive strong smartphone sales and more usage of social networks and cloud-based applications.


And then there are the wild cards, which investors haven’t even begun to price in. 

All of Big Tech is poised to benefit if Facebook CEO Mark Zuckerberg’s vision of a mixed reality “metaverse” comes to fruition. 

He sees people working, socializing, and transacting all within an even more expansive internet.

Apple is weighing an entry into the automobile market, while Alphabet could dominate the future of autonomous cars through its Waymo unit. 

Amazon and Apple are both taking a stab at healthcare and fitness. 

Facebook hasn’t even tried making money off WhatsApp, its global messaging platform with about two billion users.

The investment upside applies across Big Tech, but each company has different opportunities and challenges. 

Here’s a closer look at the Big Tech five:

Amazon

Amazon best illustrates the current risks—and untapped potential—of the group. 

Its stock has been under pressure since late last month, when Amazon said it was seeing a slowdown in e-commerce growth as more people leave home to shop.

Amazon is also in the crosshairs of regulators and lawmakers. 

The FTC is reviewing the company’s proposed acquisition of the MGM film studio. 

The primary question is whether to allow the big to get bigger. 

Should the agency seek to block the deal, it would signal a shift in how regulators approach tech consolidation. 

But don’t expect a rejection to move Amazon’s stock in the long term. 

MGM films would be a nice addition to Amazon’s Prime Video offering, but they won’t move the needle on the company’s bottom line.

In testifying to Congress last year, Amazon’s founder and then-CEO Jeff Bezos said, “I believe Amazon should be scrutinized. 

We should scrutinize all large institutions, whether they’re companies, government agencies, or nonprofits. 

Our responsibility is to make sure we pass such scrutiny with flying colors.”

That said, investors could miss the big picture by focusing on Amazon’s battles with regulators. 

The company offers an opportunity to invest in three of the most important elements of the current economy: online commerce, cloud computing, and transportation logistics. 

Amazon also has a growing advertising business, and big ambitions in healthcare and bricks-and-mortar retail. 

This past week, The Wall Street Journal reported that Amazon is planning to open department-store-style retail outlets.

Even with a $1.6 trillion current market valuation, Amazon might be a bargain based on its cloud business alone. 

Growth at Amazon Web Services is accelerating, and revenue from the unit could hit an annualized $100 billion by 2023. 

Valuing that business at, say, 15 times sales (most cloud application companies fetch higher valuations than that), gives you a market cap of $1.5 trillion, meaning that investors are getting Amazon’s e-commerce business and its nascent advertising business almost for free.

Amazon stock has been basically flat for a year. 

At some point, investors will do the math.

Apple

The iPhone maker’s shares have doubled since the end of 2019, increasing the company’s market capitalization by more than $1 trillion. 

Apple grew sales 36% in its latest quarter, following 54% growth in the March quarter—the company’s two best quarters since 2012.

Apple, meanwhile, is more diverse than ever. 

While the latest iPhone 12 is a hit, with sales up almost 50% in the latest quarter, everything else is working, too. 

The company continues to see double-digit growth for its Macs, iPads, and wearables businesses. 

Apple’s services segment grew 33% in the latest quarter. 

All told, the iPhone is now about 50% of Apple sales, down from 66% in 2015.

There are near-term headwinds, however. 

A few weeks from now, Apple will unveil its follow-up to the iPhone 12. 

The upgrades are expected to be modest, and Apple has already warned that it could have trouble meeting demand because of worsening component shortages.

Among the Big Tech group, Apple could face the most immediate regulatory risk, given growing complaints about its hefty 30% commission rate on sales in its App Store. 

Epic Games sued Apple over the issue—a decision on the case is pending—and the situation has received attention in Washington. 

In July, three dozen state attorneys general sued Alphabet over the fees charged by its Google Play store, and a parallel action against Apple seems inevitable.


The five largest tech stocks now have a combined market value of $9 trillion. 

Wall Street forecasts suggest there’s plenty of growth still to come.

In defending the App Store to lawmakers last year, Apple CEO Tim Cook said, “For the vast majority of apps, developers keep 100% of the money they make. 

The only apps that are subject to a commission are those where the developer acquires a customer on an Apple device and where the features or services would be experienced and consumed on an Apple device.”

App tracker Sensor Tower, estimates that Apple generated commissions of $21.7 billion from the App Store in 2020, or about 8% of its annual revenue. 

Even if Apple is forced to cut its 30% commission in half, the hit would be less than 5% of Apple’s total revenue.

Gene Munster, managing partner at the investment firm Loup Ventures, is bullish on the whole set of tech megacaps, but he has a particular preference for Apple, a company he once covered as an analyst at Piper Jaffray. 

He concedes that Apple is headed for a step down in growth but thinks that Wall Street is too negative. 

He sees Apple still growing sales 10% in its upcoming 2022 fiscal year, versus a 3.4% forecast from analysts.

The wild card for Apple investors is the possibility that the company jumps into making cars. 

Munster puts the chances at less than 50%, but says that if it happens, it would be a “measurable multiple expander” for the stock. 

Apple currently trades at 26 times earnings estimates for the next 12 months; Tesla (TSLA) fetches an earnings multiple north of 100.

Microsoft

Microsoft has thrived in the pandemic era, as more companies adopted digital processes to ensure their survival in a world of shuttered offices and limited travel. 

The surge in PC demand triggered by the work-from-home trend has boosted the Windows business, lifted sales of Microsoft’s Surface line of tablets and laptops, and buoyed demand for its Xbox videogame consoles. 

The company has even seen a pickup in ad revenue, thanks to both the company’s Bing search engine and growth on LinkedIn, which, as of the latest quarter, is generating revenue at an annualized rate of more than $10 billion.

But the core driver has been the growth of the company’s Azure cloud business—sales were up 51% in the latest quarter—and accelerating adoption of cloud-based versions of Microsoft’s software, including Office and its communications suite called Teams.

“I shudder to think what the world would have been like if it were not for digital technology and the cloud and collaboration platforms like Teams,” said Microsoft CEO Satya Nadella in a recent Barron’s interview. 

“Even five or 10 years ago, I think we would have been in deep trouble.”

Microsoft’s revenue grew 18% for the June 2021 fiscal year, and the company projects “healthy” double-digit revenue growth for fiscal 2022. 

But that steady growth does not come cheap. 

Microsoft has a market value of $2.2 trillion, which makes it the world’s largest company after Apple. 

And it trades for 33 times earnings estimates for the next 12 months, making it the most expensive name in Big Tech relative to growth.

But for risk-averse investors, Microsoft is also the least vulnerable to regulation. 

Once the primary target of antitrust regulators, the company has been largely left out of the current regulatory debate.

Alphabet

The opportunity in online advertising, the primary domain of Alphabet (and Facebook), might get less attention than the cloud and smartphones, but it is no less compelling. 

In the recent June quarter, Alphabet’s ad sales grew 69%.

YouTube’s ad revenue soared 84%, to $7 billion, in the second quarter, putting the business on par with Netflix (NFLX), which reported quarterly revenue of $7.3 billion. 

Netflix is expected to grow sales by 19%, to $29.7 billion this year, while YouTube’s ad revenue is forecast to rise 45%, to $28.7 billion.

Alphabet’s growth isn’t fully appreciated. 

Alphabet’s Class A shares fetch an inexpensive 26 times forward earnings.

“You’re paying a market multiple for the core Google ad-services business, and then you’re getting the cloud and all the other bets for free,” says Mitch Rubin, chief investment officer at RiverPark Funds.

Illustration by Nicolas Ortega


Some of the other bets could soon come in focus. 

The company started breaking out results for its cloud computing unit last year. 

In the recent quarter, it slashed operating losses for the cloud by more than half. 

While rivals Amazon and Microsoft remain fierce competitors, Alphabet has a mix of artificial intelligence and machine learning that will be key to driving Wall Street’s forecasted cloud growth of 51% this year.

The core business—search advertising—is doing just fine meanwhile. 

Google remains the world’s largest seller of advertising, and YouTube accounts for just roughly 11% of revenue.

Google represents more than 90% of internet search visits in the U.S., and its clear dominance there makes it an obvious target for regulators.

Alphabet is facing antitrust litigation from the Department of Justice and multiple state attorneys general over alleged monopolistic practices in search advertising—a threat to the company’s oldest-running moneymaker.

Alphabet called the lawsuits misleading, flawed, and dubious, and vowed to defend itself in court.

Facebook

Facebook generates the most controversy of the Big Tech firms. 

In recent weeks, the social networking giant has drawn the ire of the White House over its treatment of Covid-19 vaccine misinformation, and some lawmakers have spoken out about what they perceive to be violations of their free speech. 

Through it all, though, Facebook has remained a compelling stock, an opportunity that Barron’s highlighted in an April cover story.

Even after a 30% gain this year, Facebook shares trade at just 23 times forward earnings, making it the cheapest of the Big Tech stocks and just a bit more pricey than the S&P 500, even though Facebook remains in clear growth mode.

“For an asset that can grow earnings over the next three years at something close to 30%, I think that’s highly attractive,” says Evercore’s Mahaney. 

“There is a lot of valuation support for where the stock is now.”

One area that gets overlooked by investors is Facebook’s growing focus on commerce. Facebook now has 1.2 million active shops, where small and medium-size businesses can tap Facebook’s enormous social network to sell their wares.

Shopify (SHOP), which provides similar e-commerce tools to businesses, is valued at $183 billion. That is the kind of value that could accrue to Facebook over time.

And seven years after buying WhatsApp, Facebook has turned the service into a global phenomenon. The company is slowly adding payment transfers to the app, making it a potential rival to PayPal Holdings ’ (PYPL) Venmo.

There could be near-term hiccups, though. Facebook’s ever-conservative chief financial officer, David Wehner, has warned investors that revenue growth will slow modestly for the rest of the year, even when compared with the pre-Covid, 2019 numbers.

Privacy changes from Apple have complicated ad targeting on some of Facebook’s mobile apps. 

The company has suggested that its third-quarter results could be affected by the changes.

Then there’s the potential regulation. 

A Facebook spokesman called the FTC’s revised lawsuit against the company “meritless,” saying that “the FTC’s claims are an effort to rewrite antitrust laws and upend settled expectations of merger review, declaring to the business community that no sale is ever final.”

So far, the agency’s efforts have just highlighted the high bar facing regulators.

In dismissing the FTC’s initial lawsuit against Facebook, Judge James Boasberg of the U.S. District Court for the District of Columbia wrote, “It is almost as if the agency expects the court to simply nod to the conventional wisdom that Facebook is a monopolist.”

Investors have done well by ignoring such conventional wisdom. Since Barron’s first highlighted the regulatory threat for Big Tech in an October 2017 cover story, the five stocks have returned an average of 218%, versus 84% for the S&P 500.

Investors will probably see continued gains from the stocks, even as regulators work overtime to make their case against Big Tech.

Doctors Join the Climate Lobby

Don’t they know that poverty kills far more people than heat does?

By The Editorial Board

A LinkNYC street kiosk warns of the Extreme Heat Alert in the Chelsea neighborhood of New York, .PHOTO: RICHARD B. LEVINE/ZUMA PRESS


Medical journals are supposed to be forums for doctors to publish research and debate ideas. 

But like traditional media outlets, many are finding it harder to control their political bias. 

Now some 200 journal editors are showing their political hand on climate change in an apocalyptic and misleading joint editorial this week that could have been ghost-written by Greta Thunberg.

The groupthink in these journals suppressed debate over important questions during the Covid pandemic, including the origins of the virus and the costs of lockdowns. 

Now these same experts want to tell everyone what to do about climate, which they know less about than geologists do about cancer.

“No temperature rise is ‘safe,’’’ the editorial says. 

“Higher temperatures have brought increased dehydration and renal function loss, dermatological malignancies, tropical infections, adverse mental health outcomes, pregnancy complications, allergies, and cardiovascular and pulmonary morbidity and mortality.”

The editorial cites a recent British Medical Journal meta-analysis of studies that examine links between extreme weather and health outcomes. 

But most findings haven’t been replicated, many conflict, and correlation doesn’t prove causation. 

Obesity has increased at the same time temperatures have. 

That doesn’t mean heat is making people fatter.

Worse are the editorial’s deceptive statements such as global warming is “contributing to the decline in global yield potential for major crops,” which is “hampering efforts to reduce undernutrition” (our emphasis). 

But actual crop yields have been increasing thanks to better agricultural practices, plant genetics and, yes, higher CO2 levels.

Extreme cold kills many more people each year (1.3 million) than extreme heat (356,000), according to a study published in the Lancet last month. 

Deaths from cold weather have increased at a slower rate than the population, no doubt in part because more of the world’s poor now have heating.

But facts are beside the point since the editorial’s intent is to scare people before the global climate gabfest in November and lobby for more income redistribution. 

Many Western countries have already committed to phasing out fossil fuels, but the editorial says these “promises are not enough.”

It’s true that wealthy countries could eliminate almost all emissions, and it wouldn’t matter if China, India and low-income countries continue to industrialize. 

China’s greenhouse gas emissions in 2019 exceeded those of all countries in the developed world combined.

Which is why the editorial calls for rich countries to donate more than $100 billion annually to poorer ones, plus forgive debts that “constrain” climate investments. 

“Huge investment will be needed, beyond what is being considered or delivered anywhere in the world,” the editorial says, pointing to the trillions that governments spent to fight the pandemic.

But we don’t live in a world of infinite resources, and there are far better ways for governments to spend money if the goal is to improve global public health—for instance, vaccinations. 

The experts are essentially telling rich countries to tax their middle classes to send money to the rest of the world. 

But what poor countries need is to get richer, which requires energy, which requires fossil fuels at least until there is some technological energy breakthrough.

Poverty kills far more people each year than anything else. 

About 10% of the world’s population currently doesn’t even have electricity, and a third still cook with stoves that use wood, coal, crop waste or dung, which kill millions each year. 

Gas-fired stoves would be a huge upgrade, but that would upset rich-world climate alarmists.

To keep the world from warming more than 1.5 degrees Celsius, global energy consumption would have to fall 7% over the next decade, according to the International Energy Agency (IEA). 

That means no air conditioning or cars for sub-Saharan Africa. 

A solar farm the size of the world’s current largest solar park would have to be installed roughly every day. 

That would reduce farmland.

The IEA also warned this spring that increased mineral mining for renewables could cause “biodiversity loss and social disruption due to land use change, water depletion and pollution, waste related contamination, and air pollution” as well as human-rights abuses and worker injuries. 

All not-so-terrific for public health.

The main result of this climate advocacy will be to underscore that these medical journals are increasingly more about politics than medicine or public health. 

They are less authorities than partisan advocates.

Honey, Who Shrunk the World?

By Paul Krugman

      Credit...Coley Brown for The New York Times


When I was in my 30s, my parents gave me a sweatshirt bearing the words “Global shmobal.”

At the time, I was going to many economics conferences; when my parents would ask me what the latest conference was about, I apparently always replied, “Global shmobal.”

What I didn’t know at the time was that the global was about to get even shmobaler. 

In the mid-1980s, world trade had recovered from the disruptions and protectionism of the interwar period, but exports as a share of world G.D.P. were still back only to around their level in 1913. 

Starting around 1988, however, there was a huge surge in trade — sometimes referred to as hyperglobalization — that leveled off around 2008 but left the world’s economies much more integrated than ever before:

           Exports as percentage of world G.D.P. Credit...World Bank


This tight integration has played an important background role in pandemic economics. 

Vaccine production is very much an international enterprise, with production of each major vaccine relying on inputs from multiple nations. 

On the downside, our reliance on global supply chains has introduced forms of economic risk: One factor in recent inflation has been a worldwide shortage of shipping containers.

But how did we get so globalized? 

There are, it seems to me, two main narratives out there.

One narrative stresses the role of technology, especially the rise of containerized shipping (which is why the box shortage is a big deal). 

As the work of David Hummels, maybe the leading expert on this subject, points out, there has also been a large decline in the cost of air transport, which is a surprisingly big factor: Only a tiny fraction of the tonnage that crosses borders goes by air, but air-shipped goods are, of course, much higher value per pound than those sent by water, so airplanes carry around 30 percent of the value of world trade.

By the way, pharmaceuticals, presumably including Covid-19 vaccine ingredients, are mainly shipped by air:

This is what it looks like when drugs fly. Credit...Brookings


An alternative narrative, however, places less weight on technology than on policy. 

That’s the narrative one often sees associated with Trumpists (although they’re not the only ones with something like this view): Globalists pushed to open our borders to imports, and that’s why foreign goods have flooded into our economy.

And the truth is that from the 1930s up to Donald Trump, the U.S. government did, in fact, pursue a strategy of negotiating reductions in tariffs and other barriers to trade, in the belief that more trade would both foster economic growth and, by creating productive interdependence among nations, promote world peace.

But the long-run push toward more open trade on the part of the United States and other advanced economies mostly took place before hyperglobalization; tariffs were already very low by the 1980s:

Tariffs over time. Credit...USITC


While there weren’t big changes in the policies of advanced economies, however, there was a trade policy revolution in emerging markets, which had high rates of protection in the early 1980s, then drastically liberalized. 

Here’s the World Bank estimate of average tariffs in low and middle-income countries:

Average tariffs in low- and middle-income nations. Credit...World Bank


You might ask why a reduction in emerging-market tariffs — taxes on imports — should lead to a surge in emerging-market exports. 

So let’s talk about the Lerner symmetry theorem — or, actually, let’s not and just say that tariffs eventually reduce exports as well as imports, typically by leading to an overvalued currency that makes exporters less competitive. 

And conversely, slashing tariffs leads to more exports. 

Basically, nations can choose to be inward-looking, trying to develop by producing for the domestic market, or outward-looking, trying to develop by selling to the rest of the world.

What happened in much of the developing world during the era of hyperglobalization was a drastic turn toward outward-looking policies. 

What caused that trade policy revolution and hence helped cause hyperglobalization itself?

The immediate answer, which may surprise you, is that it was basically driven by ideas.

For more than a generation after World War II, it was widely accepted, even among mainstream economists and at organizations like the World Bank, that nations in the early stages of development should pursue import-substituting industrialization: building up manufacturing behind tariff barriers until it was mature enough to compete on world markets.

By the 1970s, however, there was broad disillusionment with this strategy, as observers noted the disappointing results of I.S.I. (yes, it was so common that economists routinely used the abbreviation) and as people began to notice export-oriented success stories like South Korea and Taiwan.

So orthodoxy shifted to a much more free-trade set of ideas, the famous Washington Consensus. 

(Catherine Rampell suggests that should be the new name for D.C.’s football team. Nerds of the world, unite!) 

The new orthodoxy also delivered its share of disappointments, but that’s a story for another time. 

The important point, for now, is that the change in economic ideology led to a radical change in policy, which played an important role in surging world trade: We wouldn’t be importing all those goods from low-wage countries if those countries were still, like India and Mexico in the 1970s, inward-looking economies living behind high tariff walls.

There are, I think, two morals from this story.

First, ideas matter. 

Maybe not as much as John Maynard Keynes suggested when he asserted that “it is ideas, not vested interests, which are dangerous for good or evil,” but they can have huge effects.

Second, it’s a corrective against American hubris. 

We still tend, far too often, to imagine that we can shape the world as we like. 

But those days are long gone, if they ever existed. 

Hyperglobalization was made in Beijing, New Delhi and Mexico City, not in D.C.


Paul Krugman has been an Opinion columnist since 2000 and is also a Distinguished Professor at the City University of New York Graduate Center. He won the 2008 Nobel Memorial Prize in Economic Sciences for his work on international trade and economic geography. 

The Return of Negative Yields... And What Comes Next

by David Stockman

Negative Yields.jpg


Among all the financial market distortions and misallocations that result from the Fed’s money-pumping policies, we are hard pressed to think of something stupider and more counterproductive than negative real yields on junk bonds.

The historic yield spread over inflation of riskiest US company securities has ranged between 500 and 1,000 basis points (5–10%) or more. 

And for the good reason that in combination, inflation and defaults always eat deeply into the coupons so as to remind investors why it is called "junk."

As it happened, the junk bond yield on the eve of the dotcom crash in the spring of 2000 was 12.48%, reflecting an 875 basis point spread over the CPI of 3.73%.

By the eve of the Great Recession in November 2007, the junk yield had fallen to 9.15% but that still represented a healthy spread of 478 basis points over the CPI, which had increased to 4.37% during the prior 12 months.

But those spreads self-evidently were not enough when the economy plunged into the tank during 2008–2009.

The reason the spread went nearly parabolic during the Great Recession is that the price of junk bonds collapsed by 26% as investors and speculators dumped them in the face of soaring losses and issuer bankruptcies that topped all previous cyclical highs (dotted line).

picture 1.jpg

 Needless to say, the Fed was not about to let Mr. Market have its way, nor honest price discovery to win out in the bond pits.

After the massive money-pumping under Bernanke, the spread was back down to about 490 basis points. 

And from there it continued lower in herky-jerky fashion throughout the subsequent so-called recovery, until it reached just 290 basis points at the pre-COVID peak in February 2020.

The rationalization for that renewed spread compression was that junk bond losses fell substantially and steadily during the course of the recovery. 

What is not mentioned is that the overwhelming reason for the decline in defaults and losses was the magic of Wall Street’s cheap debt-fueled refi machine.

Like home mortgages during the three- or four-year runup to the 2007 housing crash, junk borrowers who were in trouble or heading there got refinanced at lower rates before they showed up as a Chapter 11 filing.

Needless to say, when the combination of yields after inflation and a historic realized-loss rate of about 3.0% (after recoveries from a 4.2% initial default rate) hit essentially zero, the Fed was already deep in the zombie breeding business.

When you give junk rated companies long-term capital at essentially a zero return to investors, you are going to get a lot of demand to feed a mushrooming herd of zombies — companies that would otherwise be liquidated and their resources redeployed more productively on an honest free market.

Still, the Fed was not done by any means.

Owing to its $4.5 trillion money-printing spree since September 2019, it has essentially destroyed after-inflation returns in the sovereign debt and investment grade sectors. 

So in desperate search for yield, investors (speculators) have plowed into the junk bond market, driving yields below 4% recently.

These fools have driven the junk bond yield to a negative 100 basis points (1%) after inflation, and it will be going deeper into the red from there.

Picture 2.png


In a world of sound money and honest price discovery in the bond pits there wouldn’t be any appreciable junk bond market at all.

Companies with truly risky but worthy investment projects would sell equity, and investors looking for reliable yields would have plenty of government and investment grade corporate bonds with adequate risk-adjusted returns to choose from.

Has the Fed taken notice of the fact that the growth capacity of the US economy is being steadily eroded by the rise of a herd of corporate zombies?

Needless to say, it has not — not in the slightest.

Yet when the next junk market meltdown sends zombies stampeding toward the Chapter 11 courts, it will be totally surprised… and then prescribe another round of the kind of deadly money-pumping that already imperils capitalist prosperity.

Editor’s Note: The Federal Reserve has unleashed an unprecedented avalanche of money printing… but it won't revive the biggest financial bubble in history.

We've likely entered a downturn that could be bigger, longer, and more complicated than anything we've seen in since the Great Depression.