Q4 2012 GDP brought a few surprises. Among them, the sharp increase in nonresidential equipment and software investment, in spite of the uncertainties related to the fiscal cliff. The future of the ongoing cycle is highly dependent on the ability of businesses to go organic (invest and hire more). Below I provide a brief description of the state of corporate America.
US nonfinancial corporations are flushed with liquid assets: liquid assets have risen sharply when compared to short term liabilities. The chart below underscores an interesting pattern:
- The disintermediation process that started in the 1980s has accelerated with the crisis. Corporates have increased the pace of substitution of loans for marketable debt;
- This reduced dependence on banks came along with an increase of liquid assets as a share of short term liability (a self-imposed Liquidity Coverage Ratio).
Meanwhile, liquid assets make up more than 100% of total investment. The excess has declined from the peak of 130% that was reached just after the crisis but is still above 100%.
Interestingly enough, as total liquid assets outstanding reached $1740 bn at the end of last year, the total value of US Mergers and Acquisitions was still halfway below its 2007 peak.
What has been done with this extra cash? A natural answer would be stock repurchases. The chart below compares the change in credit market debt and the equity payout. The latter is defined as dividend paid minus net new equity issues minus proprietors' investment.
Debt repurchases and equity payouts share one common structural pattern (the structural substitution of equity for debt) and one common cyclical pattern (the reverse during economic crisis - a time when internal funds are missing and external funding becomes scarce). A glimpse at the chart above shows that there is no genuine shift in today's pattern compared to the last three decades. The extra cash that is held today does not seem to have been used excessively to provide some extra revenue to stock holders.
Even if dividend yields have declined structurally over the last decades, the value added share of net dividends has increased since the early 1990s. In addition, stock repurchases are clearly part of firms' policies since the 1990s.
There is a link between debt repurchases and equity returns, but:
- the causality is not straightforward as repurchases are low when equity prices are down; and
- The link has not broken down recently, which suggests that there is no "misuse" of the extra cash.
This analysis shows that US companies are hoarding hording cash for reasons that are linked to their liability changes and for insurance purposes. The relatively low level of M&A could suggest that they also keep cash for better external growth opportunity, as bank credit may not be as available as it once was.
Part of the cash is used for stock repurchases, but in a manner that is consistent with the past 15-years.
Lastly, there is probably part of the excess cash held either for lack of investment opportunity or an excessive level of uncertainty. Note that the latter has dwindled somewhat, and let's hope that more capital spending will spur the ongoing "slow and steady" recovery.