Liquid Assets Are at a 37-Year High on Corporate Balance Sheets

This article is a guest contribution from American Century Investments.

Market and stock analysts have recently taken note of an interesting development that began in the depths of the Great Recession. Just prior to its start (i.e. the third quarter of 2007), total liquid assets on the balance sheets of non-farm, non-financial corporations equaled $1.5 trillion and represented 5.3% of total corporate assets. In the fourth quarter of 2008—one year after the recession began and (in hindsight, at its nadir)—liquid assets dipped to $1.4 trillion or 5.1% of total corporate assets. But in the five quarters since (through the first quarter of this year), total liquid assets increased dramatically to $1.8 trillion (an increase of $400 billion) while liquid assets as a percent of total corporate assets—on a market value basis—increased from 5% to 7%.

That means that seven cents of every dollar of total corporate assets (the sum of the market value of its capital structure consisting of short- and long-term debt plus shareholder equity) is now invested in the equivalent of a corporate “piggy bank” as opposed to investments in its long-term productive capital (expected to earn a return in excess of a company’s cost of capital). As the chart below illustrates, while the long-term trend over 144 consecutive quarters from the first quarter of 1973 to the fourth quarter of 2008 has been an increase in liquid assets as a percent of total corporate assets—increasing from 4% to 5% (see the dashed line labeled LT Trend)—the sudden jump as the economy emerged from a severe recession is well above what the 35-year trend and five prior recessions would predict.

Notes:    (1) Liquid assets on corporations’ balance sheets consist of foreign deposits; checkable deposits and currency; time and savings deposits; money market fund shares; commercial  paper;  Treasury, agency and GSE-backed and municipal securities; and mutual fund shares.

(2) Business assets are measured at market value.

(3) Non-financial corporations exclude banks, thrifts, mortgage financing corporations where the primary business is lending money or extending credit.

(4) “LT Trend” (Long-Term Trend line) illustrates the linear rate of growth for liquid assets as a percent of total business assets between the first quarter of 1973 and the fourth quarter of 2008 (144 quarters).

(5) Shaded areas represent recessionary periods.

A Bullish Sign?

A number of analysts have concluded the sudden increase in liquid assets on the balance sheets of corporations is a bullish sign for the equity markets.  One rationale is based on a possible increase in corporate mergers and acquisitions (M&A) activity. History has shown that corporations with large amounts of cash will pursue acquisitions, either of competitors or as extensions of their corporate strategy. With interest rates for prime corporate borrowers at attractive historical rates and the current modest rates of overall economic growth, the argument for increase in M&A activity as a means of growth is a persuasive one. If a company can’t achieve its long-term growth targets via internal growth, M&A (especially acquisitions) can become an attractive alternative.