US Bankruptcies Flash Red Warning

The number of bankruptcy filings in the US has reached levels not seen outside of periods of extreme economic stress.

Twitter account WhaleWire warned that such figures have, in the past, suggested that the economy is about to enter recession and the stock market is heading for a crash.

Both the 2008 Global Financial Crisis and 2020 COVID response saw interest rates slashed to near zero to help stimulate economic growth, putting a rocket under risk assets in the process. As rates were raised from the end of 2021, the stock market and crypto both experienced bear markets.

Today, the Fed is entertaining the possibility that a "soft landing"—bringing inflation back to target without crushing the economy—be possible. On the face of it, these bankruptcy figures would seem to disagree with that. However, in reality the picture may be more complicated.

Leading Or Trailing Indicator?

Twitter users were quick to reply that in the past, stock markets have crashed before bankruptcies reach their highs. For example, during the GFC, the peak for bankruptcies occurred in the first quarter of 2009: Right around the time the S&P 500 bottomed out.

This is hardly surprising. The stock market tends to front-run recessions, since traders see the writing on the wall and sell quickly, before companies start to feel the pain. It's possible the same is happening this time around.

This cycle, the S&P bottomed in early October 2022 and has since been in an uptrend, though it has corrected around 6% in the last two months.

Zombie Companies

Other Twitter users suggested things were more serious than they initially appeared, since the labor market is strong despite the bankruptcies—suggesting that things might get much worse in the coming weeks and months.

All of this assumes, of course, that this time will follow the same path as the previous two. However, other factors mean the outlook is necessarily somewhat different. In the GFC, interest rates had already hit their lows when bankruptcies peaked. Today, they are at a 15-year high. It's likely that many of the bankruptcies are "zombie" companies that only survived due to the availability of cheap money. Now, as rates rise, they're finally starting to fold.

The Fed has a lever it can pull to ease the pain for businesses and households, but it has indicated that it is not yet ready to do that. The risk of resurgent inflation is too high. When the damage to the economy exceeds the damage threatened by high inflation, we might see a pivot. But that, as the Fed has told us time and again, is some way in the future.

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