by Milton Ezrati, Lord Abbett
One of the great constants in this otherwise inconstant environment is the strength of corporate finances. Financial excesses and the need to de-leverage concern governments and households, not the corporate sector, which actually came out of the 2008–09 financial crisis and recession with its finances in good order, and has only strengthened them since. The question now is how and when companies will deploy these impressive financial resources—whether on capital spending, hiring, or, especially, on the mergers and acquisitions (M&A) that typically proceed from strong corporate finances.
Huge cash holdings constitute the most impressive aspect of this financial strength. At the close of 2011 (the most recent period for which complete data are available), cash on non-financial corporate balance sheets had risen to more than $1.9 trillion—a jump of almost 60% from the dark days of 2008 and more than 50% from the last cyclical peak in 2007. Cash and cash equivalents have risen, so that today they constitute almost 13% of all corporate financial assets, up from 9.4% in 2008 and 9.1% in the cyclical peak year 2007. They amount to some 14% of all corporate liabilities, up from 9.2% in 2008 and 9.7% in 2007, and almost 12% of corporate net worth, up from 8.9% in 2008 and 8.0% in 2007.
Aside from the powerful cash flows that permitted such accumulations, it is the high and persistent levels of uncertainty that have kept the funds in cash instead of flowing into other corporate uses. Speaking volumes to this motivation is the fact that the bulk of this cash sits neither in time nor savings deposits nor money market shares nor in commercial paper, but rather in checkable deposits. These have grown remarkably—more than 1,500%, in fact—since 2008. The high level of uncertainty behind this behavior is hardly surprising either, on at least four counts.
First and primary as a behavioral motivator is the legacy of the 2008–09 financial crisis. Still fresh in managers' collective memories, these events have kept companies sensitive to how suddenly economic and financial conditions can change and, consequently, how valuable ready, liquid assets can be. But more, because bank credit standards tightened during the crisis and by and large have remained tight since, companies have lost the conviction that they can borrow should the need arise. It does not help in this regard that many banks during the crisis withheld formerly well-established corporate lines of credit, an act that has left in its wake conviction among corporations that they ought to rely more on self-financing. The sovereign debt problems in Europe, threatening a rerun of 2008–09, have only redoubled this conviction.
Second, Obamacare has contributed, too. Whether a good idea or a bad one, good legislation or not, the huge changes built into this complex law impose tremendous uncertainty on corporate decision making, particularly about hiring. The natural response in the circumstance is to hold back on major corporate decisions and the enlarged cash holdings are an obvious financial reflection of that posture.
Third, the Dodd-Frank financial reform has had its own separate influence. Although this huge piece of legislation covers only financial corporations, it does nonetheless create uncertainty among all companies about future financing, both availability and cost. In this regard, whether Dodd-Frank is good law or bad, it has surely had an effect similar to the liquidity problems of 2008–09, even though it was ostensibly designed to correct them, adding to management convictions that they can no longer rely on credit lines from financial institutions and need, therefore, to do more than previously to cover their short-term cash needs for themselves.
And fourth, if these matters did not weigh heavily enough, corporations must also cope with the uncertainties surrounding the federal budget debate. Without knowing the nature and size of future federal spending or taxes or even the federal government's prospective borrowing needs, it is difficult for managers to gain any sense of the future and, consequently, how to deploy their resources.
But for all this, there are tentative signs that corporations are beginning to use some small portion of this cash accumulation. Though compared with past cyclical standards hiring has remained subpar (hardly a surprise in such an uncertain environment), it has nevertheless picked up some in recent months. Corporations have also increased capital spending, raising such outlays by almost 8% over the course of 2011—hardly a boom, but certainly faster than sales have risen and a use for some of these surplus funds. At the same time, corporations have shown a modest willingness to extend themselves by accepting a rise in their trade and tax payables. Together, these have risen more than 13% during the past year, faster than sales and even than cash balances.
Still, it will take time before a return of confidence can move matters beyond these recent, tentative expressions. Cash and the lack of confidence it reflects remain high. There is, however, a tremendous potential for dramatic expansion in corporate spending, hiring, and M&A activity from even a modest improvement in confidence. Especially because equity market valuations these days make it cheaper to buy than to build, the M&A potential, with its always immediate market impact, looks particularly powerful.
The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.
The opinions in the preceding commentary are as of the date of publication and subject to change based on subsequent developments and may not reflect the views of the firm as a whole. This material is not intended to be legal or tax advice and is not to be relied upon as a forecast, or research or investment advice regarding a particular investment or the markets in general, nor is it intended to predict or depict performance of any investment. Investors should not assume that investments in the securities and/or sectors described were or will be profitable. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy or completeness of the information. Investors should consult with a financial advisor prior to making an investment decision.
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