The other argument for why an increase in liquid assets on the balance sheets of corporations is a bullish sign is based on the anticipation of a robust jump in economic growth as we move beyond the recent Great Recession. While many macroeconomic indicators in the first quarter, such as GDP growth (only 2.7%), the unemployment rate (9.7%), and industrial capacity utilization (approximately 80%), have remained bearish, the large amounts of investable liquid assets on corporate balance sheets are available to be put to quick use once aggregate demand accelerates as is typical coming out of a recession.
A Bearish Sign?
As always, there are also bearish arguments to help justify the sudden growth in liquid assets as a percentage of total corporate assets. The primary argument has to do with uncertainty by corporations and businesses in general. A lot has changed since the Great Recession began, including the election of the Obama administration plus a supermajority in Congress. Major pieces of legislation have passed or are being promoted, and corporations are still trying to assess the ultimate costs.
Another view is that corporations are conserving cash and liquid assets until signs of basic improvement in the macroeconomic outlook justify spending and investing. While this was noted as a bullish argument in the last section, the market bears note that a reluctance to anticipate a strong recovery by corporations is a tacit expression that the risk of sliding back into a second (double-dip) recession is a possibility, albeit an unlikely one.
Some analysts have examined recent, sudden growth in corporate liquid assets in light of corporate borrowings and leverage.Ā One reason is that growth in liquid assets accompanied by growth in leverage would not constitute an improvement in corporate balance sheets since increasing debt would be matched by growing pool of liquid assets. As the chart below illustrates, between the first quarter of 1973 and the first quarter of 2003, corporate liquid assets as a percentage of liabilities has averaged approximately 20%.
However, that ratio has increased from 20.1% in the fourth quarter of 2008 to 25.6% in the first quarter of this year. A closer look at the trends underlying this sudden spike show that liquid assets have increased by the $400 billion noted earlier while corporate liabilities have increased by approximately only $100 billion, with nearly all of that increase coming in just the first quarter of this year. If this is a signal that corporations are still having difficulty accessing credit from beleaguered financial institutionsāand this trend continuesāit could represent a bearish sign for growth and recovery.
Notes:Ā Ā Ā (1) Liquid assets on corporationsā balance sheets consist of foreign deposits; checkable deposits and currency; time and savings deposits; money market fund shares; commercialĀ paper; Treasury, agency and GSE-backed and municipal securities; and mutual fund shares.
(2) Corporate liabilities consist of credit market instruments (commercial paper, corporate bonds, bank loans), and miscellaneous payables (trade, taxes, pension fund)
(3) āLT Averageā (dashed line) is the 37-year average (149 quarters from the first quarter 1973 to the first quarter 2010) of corporate liquid assets as a percent of corporate liabilities.
(4) Non-financial corporations exclude banks, thrifts, mortgage financing corporations where the primary business is lending money or extending credit.
(5) Shaded areas represent recessionary periods.
Summary
Whether bullish or bearish, the rapid growth in corporate liquid assets does reflect one undisputable fact: This sector of the economy generally responded quickly and effectively to the Great Recession, cutting costs, shedding excess inventory and curtailing unnecessary investments. As a result, corporations are poised to perform well based on the overall strength of the current economic recovery. Earnings growth over the past five quarters has been impressive. However, whether this trend and rate of earnings growth can continue will increasingly depend on what happens to the top line (revenues). And in turn, much of what happens here will depend upon the willingness of consumers to regain confidence in the economic outlook and resume spending.
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