Are Businesses Quietly Preparing for a Financial Apocalypse?

By: Dan Steinhart | Tue, Oct 9, 2012
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US corporations are sitting on more cash than at any point since World War 2.

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.

Corporate Cash

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;

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.

 


 

Dan Steinhart

Author: Dan Steinhart

Dan Steinhart,
Managing Editor, The Casey Report
Casey Research, LLC.

Dan Steinhart

Having worked in the trenches of Wall Street from 2008 to 2011, Dan experienced firsthand the worst financial crisis since the Great Depression. From spending 20-hour days sorting out the derivatives mess that brought the global economy to its knees, to watching his once lucrative clients like Bear Stearns, Lehman Brothers, and Merrill Lynch drop like flies, Dan's investment and financial experience extends well beyond his years.

A CPA and Big 4 accounting firm alumni, Dan's professional experience is as broad as it is deep. He's worked with every type of financial company under the sun: from private equity firms to high-frequency traders to investment banks, name an investment discipline, and there's a good chance Dan has been there and done that.

Dan is currently managing editor of The Casey Report where he combines his financial experience with a background in auditing and tax to cast a skeptical eye on the global investment landscape. His mission is to make money for subscribers by sniffing out major investment trends before the crowd... and, as importantly, to help subscribers avoid losing money in today's increasingly distorted and politicized markets.

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