‘Cries of pain’ from smaller companies are muted by enthusiasm elsewhere in the market, but rising insolvencies point to a looming recession, says SocGen

  • Smaller companies are struggling under the weight of interest rates, and rising insolvencies are a signal of recession.
  • According to Societe Generale, lending conditions for small companies are the same as during the economic downturn.
  • “The notion that we are at the beginning of a new economic cycle seems preposterous to me,” wrote Albert Edwards.

Big Tech stocks and the “Magnificent Seven” that have delivered big gains for the S&P 500 this year may be getting all of investors’ attention, but there is another, arguably more important segment of the market that is quietly struggling, and its problems are a sign of a looming recession likely to be looming .

That’s according to Societe Generale’s Albert Edwards, who noted in a Thursday note that not only would the benchmark stock index show losses were it not for the participation of the biggest technology players, but their growth this year has actually masked “cries of pain” in smaller companies across the economy .

“Screams of joy, weighted by mega hats, drowned out cries of pain elsewhere,” Edwards wrote. “You only have to look at smaller publicly traded and untraded companies to see the torture being inflicted by the Fed’s rate stranglehold.”

The equally weighted S&P 500 index is down about 5% this year, as is the Russell 2000 small-cap index.

Companies with fewer than 100 employees, while perhaps less brilliant than an AI leader like Nvidia, are important to the economy because they account for more than half of all job growth, and these companies are currently struggling under the weight of high interest rates.

“[M]it seems that all investors, including those focused on the high yield market, have gotten it into their heads that the rising insolvency/bankruptcy rate is a problem lagging an indicator that actually indicates the beginning of a new economic cycle. Really?”

“The notion that we are at the beginning of a new economic cycle seems preposterous to me,” Edwards said, later adding that “small business lending conditions are at recession levels.”

This year, corporate bankruptcy filings have surpassed the highest level seen in 2020, and smaller companies in particular are feeling the impact of the breakdown of the Fed’s higher and longer interest rate regime.

As pandemic stimulus funds dry up, more companies could become vulnerable to bankruptcy, especially “extended life support zombie companies.”

Chart of the number of Societe Generale bankruptcies in 2023

Number of U.S. corporate bankruptcy filings by year

General Society; S&P Global Market Intelligence

Societe Generale predicts that speculative defaults could rise well above the current rate of 4.7% as well as the suggested market peak of 5.2%.

He added that tighter lending conditions tend to precede or accompany declines in profits for smaller companies, which in turn leads to declines in job growth.

“Post-pandemic labor shortages (reflected in wage resilience) should not obscure the fact that smaller companies are being trampled not by the Fed’s Magnificent 7 but by the Fed’s 7 Horseman of the Apocalypse,” Edwards said.

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Image Source : markets.businessinsider.com

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