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Getting Healthy

Investors expect a slow recovery, partly because they believe that households and firms must rebuild finances and improve their financial health before they can spend once again. Main Street is getting healthier, as household wealth recovers and people pay down debt. Corporate America is far ahead and has already greatly improved its condition. And soon, companies will start hiring, which will enable households to reinforce the economic recovery.
 
Businesses retrenched at a remarkable speed following Lehman’s demise. They cut employees, costs and inventories in a panic over self-preservation. Everyone retrenched, including consumers who cut back sharply on discretionary expenditures, but businesses actually cut capacity and production even more than sales declined. As a result, profit margins increased even as the economy continued to decline and unit labor costs declined! Companies also cut dividends to preserve as much cash as possible. As a result, corporate America is now sitting on more than $1 trillion in cash, even as the bond market reopened more than a year ago and companies have been borrowing aggressively to refinance debt at attractively low yields.
 
The corporate sector is not without challenges. The commercial real estate market is considered very troubled, yet cash is building rapidly to take “advantage” of troubled sellers who might be forced to dump properties at low prices. Public real estate investment trusts have issued equity, sold bonds, and cut dividends to accumulate cash to become active buyers.   Several companies have executed IPOs for the sole purpose of buying liquidated properties. While it is clear that some real estate companies overpaid and got themselves in trouble, there are now plenty of players on the sidelines anxious to buy. This will help restore a real market, where sellers who are not in trouble will also be able to sell at market prices.
 
The pileup of cash is already translating into positive developments for the economy. Capital investment is rising. Firms are doing strategic acquisitions to capture competitors, pick up incremental sales, gain access to new technology or just to improve efficiency by cutting costs. And with profits rising, companies are still building cash, so dividends are also being restored. This is placing the corporate sector at the forefront of the recovery.

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