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Cheap Debt Is Good News For Stocks

The liquidity preference theory, originally described by John Maynard Keynes in his General Theory, suggests that interest rate levels are determined by the demand for money. During times of high uncertainty, individuals and businesses exhibit greater demand for liquid assets, primarily cash and cash equivalents.

As uncertainty comes out of the system, pent-up cash balances need to be deployed. Considering how cheap some stocks are, the size of companies' cash balances, and the impressive performance of the below-investment grade lending market, there is now a possibility of a resurgence in buy-outs and M&A-driven consolidation as private equity investors and corporate entities "put their money to work."

The recent increase in the issuance of covenant-line loans - that is, loans with less stringent restrictions on collateral and payment terms for borrowers - can be interpreted as a harbinger for higher volumes of leveraged buy-outs, in particular. The history of covenant-lite loans is traceable to investments by private equity groups. The return of LBOs and M&A activity would generally provide support for equity prices, which is something for all investors to note.