Wednesday, October 10, 2012

Are Businesses Quietly Preparing for a Financial Apocalypse?

Dan Steinhart
Casey Research

US corporations are sitting on more cash than at any point since World War II.

That's without including banks. I'm only talking about nonfinancial corporations – the ones that sell goods and services and make the economy go.

Those businesses hold $1.4 trillion. In absolute terms, that's the most ever. In relative terms, it's the most since World War II.

As investors, we can infer quite a bit from corporations' inability (or unwillingness) to deploy their cash.

For one, it indicates that business have assumed a very defensive stance.

Cash, of course, is a buffer against uncertainty - the uncertainty that business slows for any reason. Management wants a healthy cash reserve with which to pay the bills and remain liquid should anything unexpected happen. I think we can all agree that this is prudent, and a good business practice.

But $1.4 trillion? That tells me that businesses are not just a little jittery about the future. They're prepared for an apocalypse.

Think about this, it’s important;
  • If these businesses could conjure up even the most marginal of projects to earn a meager 1% return, they would generate $14 billion profit. Instead, they're sitting on the cash and earning near zero for a guaranteed after-inflation loss.
It's a bad omen that corporate management would forego a collective $14b per year. Clearly, by their judgment, the risk of investing in new projects outweighs the reward – the exact opposite of the conditions needed to produce healthy economic growth.

That's the bad news. But here's the good, if paradoxical, news:

Even with all of this corporate slack, earnings and profit margins are very healthy, and stocks have performed quite well. Case in point, the S&P 500 is up 15% YTD.

Why the disconnect?

Well, the rising margins and earnings are easy to explain: corporations have cut costs over the past few years, becoming leaner and more efficient. This also partially explains higher stock prices.

But I think there's another contributing factor to rising stock prices: the downright terrible outlook for bonds. Our analysis of stocks vs. bonds indicates that stocks are by far the better investment today.
The overriding reason is simple: at near zero interest rates, bonds offer almost no upside and catastrophic downside.
Simply by virtue of not being bonds, stocks have done well.

Back to that pile of corporate cash. There's no question that it's a waste today. But today's waste is tomorrow's potential.

Corporations aren't going to sit on that cash forever. Eventually conditions will be such that they'll either want to or have to invest in new projects.

Perhaps inflation will be the catalyst – corporations can tolerate losing 1.7% per year today. But if the inflation rate heats up to, say, 4%, you can bet that corps will be scrambling to deploy that now idle cash into whatever mediocre projects they can rustle up.

When that happens, they have $1.4 trillion in cash ready to go. No need to negotiate a loan. No need to issue equity to raise funds. They have all the fuel they need. The gas tank is full.
So while the economy has plenty of problems, and stocks are a far better bet than bonds, lack of cash is not one of them.

Companies are ready to invest and grow. They just need an economic and political environment conducive to doing so.


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Anonymous said...

Just curious what will happen to that 1.4t when the dollar crashes? There is no recovery without a consumer. The consumer is broke thanx to these mega corporations.

dogismyth said...

stupid article and very simplistic. Place another line on the chart showing the federal debt or $$s in circulation. Why do bloggers post crap they know nothing about.

Anonymous said...

YES-yes-yes, who would spend their money to start hiring folks if it will cost you more than you can get out of their production? NAFTA & Nixion doing the default in 1971, closing the gold window! France wanted real money ,not Federal Reserve Notes ,now worthless! Gold has not gone in price, the dollar has lost is place as the world reserve currency & you can be sure all of our people in DC know it & they are parking their wealth off shore, Caman Islands is the place they like, just ask any one in congess!

Anonymous said...

"Corporations aren't going to sit on that cash forever. Eventually conditions will be such that they'll either want to or have to invest in new projects."

Has it even occurred to this author that these corporations may well be holding onto that cash in order to help facilitate a republican victory in 2012? In other words, holding the economy hostage in order to receive more favorable tax treatment at the hands of rMoney?

Anonymous said...

Or maybe the government has been robbing us of our cash to ensure we remain and grow as their helpless dependents with a Democratic victory.

Anonymous said...

Thank you dogismyth, its not an apocalypse they are preparing for but it is more of a defensive strategy to leverage risk of having a lot of money invested in stocks and securities. From MM and Mutual Funds they can earn an almost steady ROI which are very low risk. They have also started piling up cash because they are learning from 2008 and previous crashes (finally). And I hope everyone paid attention to the percentage; it is a mere 8-9% of their cash and securities. If they were preparing for an "Apocalypse", this number would be much, much higher.. Dont beleive everything you read guys.

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