There are more and more zombie companies emerging from the COVID-19 pandemic, propped up only by Government stimulus.
According to Principal Global Investors and Edge Asset Management, there were numerous companies which had failing business models but remained in business thanks to cheap credit and easy lending conditions.
This was particularly present in areas such as industrials, consumer discretionary and energy.
The issue presented problems for passive investors who may be unknowingly invested in these companies via a passive or index-tracking fund.
Seema Shah, chief market strategist at Principal, and Dan Coleman, chief investment officer at Edge, said: “As we head into a period of uneven recovery, struggling companies will need to produce strong earnings growth to validate extended validations or eventually need to face their weaknesses. In other words, today’s equity market is one in which top-heavy valuations, outsized sector exposure and a preponderance of zombie firms still eluding bankruptcy is creating undue risk to millions of passive investors who have been participating in the rally”.
There were further problems in the stockmarket caused by those companies which remained unprofitable, particularly in the technology space where share prices had risen strongly for the past year.
“Technology will continue to be an intrinsic part of any successful company’s growth story, and the pandemic has simply expedited this trend. And while we believe many of the mega-cap names that have been leading markets have compelling reasons to be doing so, investors need to be discerning when allocating equity risk and not blindly following the trend.
“For example, there are many well-known technology companies that have yet to make a profit, but have been key beneficiaries of the flow of capital into broad indexes. Until April 2020, these profitless companies were struggling to make meaningful gains in equity markets. Then, as central bank liquidity and government fiscal support became abundant, investors rushed to find companies that may have untapped value in the belief that—with so much policymaker help—the only direction for stocks was up.”
