If you're looking exclusively at public companies to assess the health of U.S. businesses, you're missing a big piece of the puzzle.

Why it matters: By many measures, public companies came out of the pandemic financially stronger than they were going into it; that paints a rosy picture of what's happening in the economy.

• But a big chunk of U.S. economic activity is generated by smaller, private companies that don't divulge their earnings to the public — and what's happening there is very different.

Call it the "riptide" economy. Everything looks great on the surface, but underneath, unseen risks are building. That's according to a provocative new paper out Monday morning from Marblegate Asset Management, which focuses on distressed investing and private credit.

How it works: Marblegate looked at anonymized financial stats for about 1,200 private companies with revenue between $100 million and $750 million. This is representative of the cohort known as the middle market, which accounts for about a third of private sector GDP, and employs about 50 million Americans.

• Marblegate obtained the data from RapidRatings, a supply chain risk analytics firm that gets hired by corporate giants like Unilever and Under Armour to assess the financial health of all the companies in their supply chains.
• The firm compared the private company stats to averages in the Russell 3000, one of the broadest measures of U.S. public companies.

The findings: Between 2019 and the end of 2022 (the most recent full-year data), earnings before interest, taxes, depreciation and amortization (EBITDA) — a key measure of earnings — declined 24% for midmarket companies. For public companies, it soared 18%.

• EBITDA margins collapsed by 25% in the midmarket; the Russell 3000's margins only softened by 2%.
• Financial leverage, or the ratio of debt to EBITDA, rose 62% in the midmarket; in stark contrast, it declined 14% among public companies.

The big picture: "Beneath the surface of the ticker-tape economy made up of large public companies is the real economy — the middle market — with more limited access to capital," writes Marblegate in the paper.

• And larger companies have the scale that helps them better absorb financial shocks and pass on problems — like threats to their margins — to others, like their vendors, which are often midmarket companies.
• "The economic stress that has threatened the margins at large companies appears to have largely been passed on to the suppliers and vendors of the middle market," the paper says.

Where it stands: The data only goes through 2022. In 2023, rising interest costs were a major source of stress for companies across the midmarket, which mostly borrow from regional banks and private credit funds using floating-rate debt.

• (In contrast, public companies often borrow in the bond market, where they locked in lower-rate financing before the Fed started raising rates.)
• For many midmarket companies, interest costs have nearly doubled from the pre-rate hike era — and some simply can't afford it, Andrew Milgram, Marblegate's chief investment officer, tells Axios.

The impact: Bankruptcies among midmarket companies soared in 2023 —these aren't the household names that make for sexy headlines and get all the press (e.g. WeWork, Bed Bath & Beyond).

• Midmarket companies "are responsible for the vast majority of [2023's] proliferation of corporate failures," according to the paper.

The big question: How will this stress ripple into the broader economy — particularly, the labor market? After all, the strength of the labor market has driven the consumer spending growth that's been keeping the economy strong so far.

• Unemployment remains incredibly low, despite the stress in the midmarket, in part because the U.S. has a structural labor shortage and a declining workforce, Milgram notes.

What we're watching: The midmarket stress will likely lead to more defaults and bankruptcies in 2024, especially since interest rates will remain historically high even if the Fed enacts a few cuts.

• That'll probably mean losses for those companies' lenders, he adds.

The bottom line: What this growing stress means for the prospects of a soft landing, no one knows, Milgram acknowledges.

• But one thing is clear: The data describes what's happening in a non-trivial and otherwise inaccessible portion of the market. Ignore it at your peril.