It is now official, Barack Obama will serve a second four-year term as president of the United States. Despite skepticism about future economic prospects that shadowed his re-election campaign, we believe the stage is set for an upcoming U.S. economic boom driven by cash-rich companies including top ranked Berkshire Hathaway (BRK.B), Apple, Inc. (AAPL), Microsoft (MSFT), Cisco (CSCO) and Google (GOOG). An incentive to hire and invest by such companies and others will be the result of several factors.
1. Second term GDP growth effect
Since the end of World War II, there have been six U.S. presidents who have served two consecutive terms: Harry Truman - Democrat (1945 - 1953), Dwight Eisenhower - Republican (1953 - 1961), Ronald Reagan - Republican (1981 - 1989), Bill Clinton - Democrat (1993 - 2001), George W. Bush - Republican (2001 - 2009) and Barack Obama - Democrat (2009 - 2017).
Prior to Obama, the U.S. real GDP growth rate during the second term of such presidents outperformed the first term on 3 out of 5 occasions, rising by an average of 4.4% annually. Meanwhile, on the other 2 occasions, it underperformed the first term rising by an average of 2.3% annually.
U.S. GDP growth rate for two-term presidents after WWII
|Term||First Term Average GDP Growth Rate||Second Term Average GDP Growth Rate|
|Harry Truman (D)||1945 - 1953||-2.1%||+4.9%|
|Dwight Eisenhower (R)||1953 - 1961||+3.3%||+2.7%|
|Ronald Reagan||1981 - 1989||+3.1%||+3.7%|
|Bill Clinton||1993 - 2001||+3.3%||+4.5%|
|George W. Bush||2001 - 2009||+2.2%||+1.9%|
|Barack Obama||2009 - 2017||+0.7% (exp.)||?|
It is important to note that during Obama's first term, GDP growth rate of -3.1% during his first year of 2009 (due to the financial crisis) resulted in the depressed 4-year average of +0.7%. Meanwhile, during the other 3 years, GDP growth rate averaged about 2.0%.
As we believe that the financial crisis that started during Bush's second term is unlikely to repeat itself in Obama's second term, and given the fact that during Eisenhower's second term, the average GDP growth rate was still a healthy 2.7% and only 0.7% below the first term, we do believe there is a cyclical tendency following WWII for GDP growth rates to be healthier during the second term of a presidency than during the first term (although historical performance is not an indication of future performance). We did not examine earlier presidencies due the substantial difference in the prevailing monetary systems at the time, as well as the effects of WWI and WWII.
A stronger economy will lead to increased consumption, requiring expanded production. Leading companies such as Apple will have to increase their hiring and investment in order to meet rising demand. In turn, increased hiring will ultimately lead to improved compensation, which will also result in a multiplier effect for further expansion in consumption, and hence higher GDP growth rate. Such cycle will continue until it exhausts itself either through a shift in Federal Reserve policy to a contractonary policy, or in case it results in a suffocating inflationary effect.
2. Cash will not stay king
The Federal Reserve is currently pursuing an inflationary policy of quantitative easing. Such policy will have two implications on companies hoarding cash.
First, an inflationary environment will ultimately lead to higher interest rates, which in turn will negatively impact the price of intermediate term and long-term fixed income securities previously issued at low interest rates. Hence, once such companies start to fear higher interest rates, it would be to their advantage to diversify out of such securities in order to avoid principal losses.
Second, as inflation starts to rise, it will become less attractive to hold short-term cash due to purchasing power erosion. Corporations would be tempted to use some of their cash to achieve higher growth through organic hiring and expansion, as well as possibly engaging in additional research and development spending as well as contemplating acquisitions.
3. Innovate or Fade
In today's global competitive market place, long-term survival is only assured through innovation. Cash-rich companies, many of which are technology companies such as Google, Microsoft, Apple and Cisco are unlikely to survive unless they invest heavily in R&D and continue to innovate.
The recent underperformance by Hewlett Packard has been blamed on its lack of innovation and cut backs in its R&D under Mark Hurd's leadership, while Apple's success has been driven by its launch of innovative products such as the iPhone and the iPad with upgraded versions constantly improving features, user experience and functionality.
Once again, expanded R&D budgets will lead to increased hiring, increased wages, and ultimately improved products. Such products and hiring will result in additional consumption, which will lead to higher GDP growth rates, and the thirst for yet more innovative products. Such a cycle will simply continue to feed on itself, until interrupted by macro effects such as a financial crisis, or a stock market crash following a bubble caused by expectations running substantially away from reality (as happened during the internet bubble), although currently we are very far from such a scenario.
4- Consumer credit expansion
The U.S. housing market is currently on a recovery path, with reports of housing prices having gained as much as 5% from last year. As housing prices gain, homeowners equity in their most valuable asset increases, paving the way for their ability to increase borrowing and consumption.
In addition, as the housing market improves, resulting in a possible reduction in the inventory of houses available on the market, hesitant banks will increase their ability to extend new loans to consumers as such banks are able to reduce any existing inventory resulting from past foreclosures.
Consumer credit 10-year chart. Source: Y-charts
From an absolute perspective, it is evident from the above chart that total outstanding credit had recently peaked in early 2008, and it was not until late 2011 that consumer credit reached old 2008 levels again. It is also evident from the chart below how the rate of change remained negative for most of 2009 and 2010. Although such rate accelerated substantially in 2011, a sudden deceleration ensued in 2012, whereby it does appear we are now starting to move again to a higher rate of growth in consumer credit.
Once again, the recent expansion in consumer credit, which is likely to accelerate during Obama's second term, will lead to increased consumption and demand for products and services. This will in turn require companies to expand their production capacities, whereby companies with the largest cash hoard will be incentivized to spend cash to hire and expand, hence feeding an environment for further expansion in GDP growth rate, as previously discussed.
5. Political motivation
Some analysts have advocated the idea that big corporations may have been hoarding cash and jobs in order to help Romney defeat Obama. As discussed by Dan Payne on WBUR:
Give until it hurts. Another way corporations are working in concert (but not necessarily in a conspiracy) to beat Obama is by using the Citizens United decision to pour hundreds of millions of dollars into super PACs and "charitable" organizations. Nearly all of that money goes for TV ads that attack the president or Democrats in Congress, and the ads don't have to be about the economy. Because many of these groups can give anonymously, we'll never know if we're buying products and services from companies that in turn supported attack ads to hurt Obama.
Go slow on hiring. If the jobs picture had been brighter, it would send a powerful signal to the country that the recovery is under way. But that would help the president. For business, it's better to let things stay where they are to help Romney - he's promised to repeal or defund the financial regulations in Dodd-Frank that Wall Street and big banks hate. As a bonus, Romney's tax plan for the wealthy is kind to the captains of industry. He's one of them.
Now that the elections are over, the motivation for such possible behavior has faded. Furthermore, if there is truth to such motivation, it is unlikely to continue for an additional four years, as corporations would then risk losing competitiveness, innovation thrust and momentum. For those who typically dismiss such arguments as nonsense conspiracy theory, Mr. Payne adds:
Hoarding capital doesn't have to be a well-crafted, secret conspiracy. There is a natural confluence of behaviors based on common self-interest. In the final month the smart play for large employers is to wait until the day after Nov. 6, in hopes that Romney will be president.
Again, we are merely remaining open minded to such scenario as a possibility rather than a certainty. The possible positive effect of the unleashing of such cash hoard has been further illustrated by Mr. Payne:
The benefits of unleashing capital. Robert Pollin, of the Political Economy Research Institute at UMass Amherst, did a study that found:
If America's largest banks and non-financial companies moved just some of that cash into productive investments instead, that would give the economy a huge boost, creating about 19 million jobs in the next three years and lowering the unemployment rate to less than 5 percent.
6. Fading of subprime crisis and European crisis
The U.S. Federal Reserve and the European Central Bank have both undertaken a proactive stance to offset the lingering effects of the recent financial crisis. With an accommodative monetary policy, featuring quantitative easing as well as near zero interest rates through 2015, such stimulus is likely to continue to provide support to the current GDP growth rate.
A side effect of such policy is an expansion of stock market P/E multiples. Due to a recent drop in corporate earnings during last quarter, such expansion has not been felt as such, as the market basically maintained its ground in an environment of declining earnings. However, as the economy picks up steam, earnings are likely to accelerate again, hence possibly leading to a substantial appreciation in the stock market. Again, as investors feel better about the rising value of their portfolios, they are more likely to spend and consume, hence leading to further gains in GDP and employment.
As for the pending fiscal cliff, although such obstacle may present a short term risk, it is unlikely to persist for an extended period. At the end of the day, if it does extend due to bipartisanship, it will end up hurting all politicians alike, regardless of the party of the presidency.
How much of an effect can the companies with the biggest hoard of cash and investments, Apple, Microsoft, Cisco, Google and Berkshire Hathaway, have on the U.S. economy?
Apple Inc. currently has over $121.1 billion in cash and investments. It has been estimated by J.P. Morgan that the release of the iPhone 5 alone could add up to 0.5% to fourth-quarter annualized GDP growth, based on an estimate of the sale of 8 million units. Given such statistic, it is very evident that Apple's size and scope has major implications on the U.S. economy and GDP growth rate.
It has been also estimated that if corporate America invested $508 billion of its cash hoard, GDP growth rate would increase by 1% annually and 2.4 Million jobs would be created. Using such data, it is implied that if Apple spends 50% of its current cash hoard, it would boost annual GDP by 0.12% annually and create 286,000 jobs.
It is estimated that Berkshire Hathaway currently has a cash hoard of $40.6 billion. If Berkshire Hathaway invests 50% of such cash, it would create 96,000 jobs and boost annual GDP by 0.04% annually.
It is estimated that Microsoft currently has a cash hoard of $51 billion net of debt. If Microsoft invests 50% of such cash, it would create 120,000 jobs and boost annual GDP by 0.05% annually.
It is estimated that Google currently has a cash hoard of $38 billion net of debt. If Google invests 50% of such cash, it would create 90,000 jobs and boost annual GDP by 0.04% annually.
It is estimated that Cisco currently has a cash hoard of $49 billion net of debt. If Cisco invests 50% of such cash, it would create 116,000 jobs and boost annual GDP by 0.05% annually.
If Apple, Berkshire Hathaway, Cisco, Google and Microsoft spend 50% of their existing cash hoards, these 5 companies alone would generate a total of about 708,000 jobs, and increase annual GDP by about 0.3%.
As such companies continue to generate additional annual cash flow, and assuming part of such additional cash flow is also invested in productive job creating ventures, the above numbers can get an additional boost of about 20% to about 850,000 jobs and 0.36% to GDP.
When combined with part of the cash hoards of other companies, as well as part of bank deposits unallocated to loans, as well as GDP boost as a result of global consumption of produced goods generated by such spending (as in the case of Apple's iPhone5 mentioned above), such numbers can easily grow to result in a boost to GDP in excess of 2% per year.
The recent win by Obama for a second presidential term will likely result in a further boost to the average GDP growth rate during the next 4 years due to: second-term cyclical effects, diminishing returns for hoarding cash, corporate innovation, expansion of consumer credit, fading of possible political motivation to hoard cash, and a fading of the financial crisis in the U.S. and Europe. Furthermore, it is estimated that if corporate cash hoarders and banks, led by five of the largest cash hoarding companies of Apple, Google, Berkshire Hathaway, Microsoft and Cisco, spend a portion of their existing cash on job-creating ventures, annual GDP can get a further boost of no less than 2%, beyond current expectations.
Additional disclosure: I may initiate positions, either to the long side or short side, during the next 72 hours in any stocks mentioned in this article.