In a year when the S&P 500 has hit multiple record highs, few risks feel more quietly ominous than the rise of so-called “zombie companies.” These are firms that survive only by rolling over debt, unable to cover interest expenses through operating profits. With central banks pulling back pandemic-era liquidity and interest rates still elevated, the tolerance for weak balance sheets is waning. The growing presence of these financially impaired firms—especially within broader equity indices—raises serious questions about the sustainability of the current rally.
Defining Zombie Companies in 2025
Zombie companies are not a new phenomenon, but their threat feels more immediate in 2025. Defined by persistently low profitability and chronic reliance on cheap debt, zombies typically operate in low-margin industries and fail to generate enough earnings before interest and taxes (EBIT) to cover their interest payments. In the past, they limped along thanks to a decade of ultra-low interest rates and central bank support. That era is fading. According to data from Bank for International Settlements, the global share of zombie firms more than doubled from pre-2008 levels to post-2020 highs, with the U.S. market particularly exposed. The share of public U.S. firms fitting the zombie definition hovered near 15% in 2024, with some estimates suggesting it could rise even further this year.
Easy Money’s Hangover
The S&P 500’s powerful rally post-COVID was partly fueled by cheap capital. Companies with shaky fundamentals could borrow at near-zero rates and refinance perpetually. But with Fed Funds now above 5%, that game is over. Refinancing costs have jumped, and many weaker firms face maturity walls in 2025–2026. The result? A growing number are slipping toward insolvency, masked only by delayed write-downs or accounting gimmicks. This looming default wave hasn’t fully registered in equity pricing yet—but could surface in quarterly earnings and guidance. Private equity debt-fueled rollups, small-cap speculative tech, and heavily leveraged real estate investment trusts (REITs) are all feeling the pinch.
Index Contamination: A Quiet Risk
One of the most underappreciated aspects of zombie companies is their presence within major indices like the S&P 500. While megacaps such as Apple and Microsoft dominate the index’s market-cap weightings, a substantial number of mid-cap and small-cap constituents—especially in sectors like consumer discretionary, industrials, and real estate—fall into the zombie category. This means that while headline index performance may remain strong, pockets of underlying weakness persist. If zombies begin to default or get downgraded en masse, contagion could sap broader sentiment, dragging down the index even if the largest companies remain resilient.
Sector Breakdown: Who’s Most at Risk?
The consumer discretionary sector houses many marginal retailers struggling with high debt and softening demand. Think specialty clothing chains, direct-to-consumer brands, and pandemic darlings now burdened with bloated inventories and high lease obligations. Real estate, especially office and commercial REITs, is grappling with secular decline and refinancing risk. In industrials, transportation and logistics firms with thin margins and debt-heavy growth strategies are under scrutiny. Even tech, long seen as immune, has its weaker players—early-stage SaaS names burning cash with no clear profitability path and overreliant on equity issuance. Meanwhile, sectors like healthcare, utilities, and consumer staples remain far less exposed, with more stable cash flows and manageable debt levels.
Macro Headwinds: Higher for Longer Rates
The Federal Reserve’s “higher for longer” stance compounds the risk for zombie firms. If rates don’t fall meaningfully in the second half of 2025, refinancing will become prohibitively expensive for a wide swath of corporates. Already, credit spreads for junk-rated debt have widened, and distressed exchanges are increasing. Market-based indicators such as the ICE BofA U.S. High Yield Index show rising stress, and default rates are forecast to climb toward 5% by year-end. This shift in the macro regime is precisely what flushes out zombies—when the tide goes out, as Buffett famously put it, you see who’s been swimming naked.
Investor Sentiment and Credit Sensitivity
The key question is whether investors are pricing in this zombie threat. For now, the S&P 500’s resilience suggests optimism, but under the surface, credit-sensitive names are already faltering. Active managers are trimming exposure to high-debt companies, while passive index investors remain unwittingly exposed. Ratings agencies are downgrading more companies than upgrading, and earnings calls increasingly include language around refinancing risk, cost-cutting, and asset sales. Equity markets may continue to rally as long as mega-cap tech dominates, but any disruption in credit conditions could cascade downward into broader risk-off sentiment.
Historical Parallels and Lessons
History offers sobering parallels. In Japan’s 1990s post-bubble economy, zombie firms were allowed to linger through cheap financing and regulatory forbearance, which suppressed productivity and prolonged stagnation. In the U.S., the 2001–2002 tech bust exposed a wave of overleveraged growth stocks. The difference now is scale. The U.S. corporate debt market is larger than ever, and more systemic risk lies in interconnected ETFs, shadow banking channels, and private credit. The lesson: policy normalization can unearth latent fragility quickly.
What Should Investors Do?
Vigilance is critical. Investors should reassess portfolios for zombie exposure using debt-to-EBITDA, interest coverage, and free cash flow screening. High-yield bonds and speculative growth names with negative operating margins deserve close scrutiny. Defensive rotation into quality—companies with high return on equity, low leverage, and consistent operating cash flow—offers protection. Sector tilts toward utilities, healthcare, and dividend aristocrats can enhance resilience. Additionally, investors might consider credit-hedging instruments or cash-equivalent buffers to weather volatility.
Outlook: Can the Rally Survive?
Ultimately, the S&P 500’s rally rests on the strength of its biggest components. As long as megacaps continue posting strong earnings, index performance may remain intact. But the zombie threat is a slow-burning structural issue. It doesn’t need to crash markets overnight to be dangerous; it erodes productivity, confidence, and capital allocation over time. The rally may well survive, but it won’t be broad-based or bulletproof. 2025 could be the year when equity investors rediscover the importance of quality and capital discipline—because in a tighter financial world, the walking dead won’t stay upright for long.
