The Risks of the US Stock Market: Tech Giants "Feasting," Small Caps "Falling"

After a recent rise, the monthly decline of the S&P 500 index has dropped to 1.6%, but this is still the worst performance since February, and a storm is coming in September.

But let's think about the Russell 2000 small-cap index, which is down nearly 5%. Although it has risen 8% this year, these types of interest-sensitive stocks have been relatively lagging behind:

Societysorg analyst Albert Edwards updated his "most insane macro chart," showing why U.S. corporate profits have held up so well during rate hikes.

As he explained in July, these profits have mitigated the U.S. recession because companies are essentially net beneficiaries of rate hikes. Companies borrowed long-term loans at low rates in 2020 and 2021, and then lent out funds at higher short-term rates through Treasury bills and other instruments.

However, on Wednesday, Edwards claimed that "behind the giant stocks, the vast majority of companies are in big trouble." Yes, he's talking about small companies.

Andrew Lapthorne, head of quantitative equity research at J.P. Morgan, said that the significant decline in total interest payments by companies "masks huge disparities in wealth," as shown in the chart:

Edwards wrote, "Smaller listed companies in the Russell 2000 index do not have as many opportunities to issue corporate bonds, so it makes sense that they cannot lock in near-zero long-term fixed borrowing like large companies."

At this point, he retracted his conclusion from July that the U.S. is "actually immune to rising rates." "Large and giant stocks may not be affected, but the sharp increase in corporate bankruptcies is sending a clear message."

He pointed out that S&P data shows that there have been 402 corporate bankruptcies so far this year, almost on par with the 407 in 2020, just above the levels during the global financial crisis. He recommended paying attention to the American Bankruptcy Institute's data for August. Edwards cited a survey of Fed officials' opinions, saying that "the willingness of U.S. banks to lend to companies of all sizes is currently at recessionary levels."

But he said, "The real issue is that small companies are still the lifeblood of the U.S. economy, providing a large number of job opportunities." This is because giant stocks may be "vampires" sucking the blood out of these companies and others.Edwards said, "It seems that all small-cap companies in the United States are becoming desperate. Ultimately, this pain could trigger an economic recession, and even large companies may start to waver."