John Rubino: Many more bankruptcies are coming, as market psychology turns really dark

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One of the signposts on the road to recession (or in today’s case Depression) is a sudden increase in the number of former Wall Street favorites going bankrupt. The reason this happens when it does is that when money is easy, new companies are able to finance their emergence by selling a “disruptive” story to speculators who get swept up in the hype and shower those companies with cash. The companies expand aggressively, generate rising sales and come back for more cash, which is supplied enthusiastically.

During this exponential growth phase, no one pays attention to operating losses, cash flow burn rate, or any other profit metric, because it is assumed that the company will eventually get big enough to raise prices while cutting costs via economies of scale, thereby generating a tsunami of cash. Amazon did it that way, so why not these other revolutionary upstarts?

The answer is that for every Amazon there are a hundred unworkable business models, and it’s only when money gets tight that the latter reveal themselves and start to fail.

Why does this matter for investors like you who avoid speculative “story” stocks in favor of real assets and the companies that produce them? Because market psychology can turn very dark when a critical mass of big-name bankruptcies start making headlines. The resulting bear market can suck everything down in its wake, a prospect which affects the timing of, say, gold mining stock entry points.



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