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Are Businesses Quietly Preparing for a Financial Apocalypse?

Contributed by Dan Steinhart, Casey Research.

US corporations are sitting on more cash than at any point since World War II. That's without including banks. I'm only talking about nonfinancial corporations – the ones that sell goods and services and make the economy go. Those businesses hold $1.4 trillion. In absolute terms, that's the most ever. In relative terms, it's the most since World War II.

As investors, we can infer quite a bit from corporations' inability (or unwillingness) to deploy their cash.

For one, it indicates that business have assumed a very defensive stance. Cash, of course, is a buffer against uncertainty - the uncertainty that business slows for any reason. Management wants a healthy cash reserve with which to pay the bills and remain liquid should anything unexpected happen. I think we can all agree that this is prudent, and a good business practice.

But $1.4 trillion? That tells me that businesses are not just a little jittery about the future. They're prepared for an apocalypse.

If these businesses could conjure up even the most marginal of projects to earn a meager 1% return, they would generate $14 billion profit. Instead, they're sitting on the cash and earning near zero for a guaranteed after-inflation loss.

It's a bad omen that corporate management would forego a collective $14b per year. Clearly, by their judgment, the risk of investing in new projects outweighs the reward – the exact opposite of the conditions needed to produce healthy economic growth.

That's the bad news. But here's the good, if paradoxical, news:

Even with all of this corporate slack, earnings and profit margins are very healthy, and stocks have performed quite well. Case in point, the S&P 500 is up 15% YTD.

Why the disconnect?  

Well, the rising margins and earnings are easy to explain: corporations have cut costs over the past few years, becoming leaner and more efficient. This also partially explains higher stock prices.

But I think there's another contributing factor to rising stock prices: the downright terrible outlook for bonds. Our analysis of stocks vs. bonds indicates that stocks are by far the better investment today.

“The overriding reason is simple: at near zero interest rates, bonds offer almost no upside and catastrophic downside”

Simply by virtue of not being bonds, stocks have done well.

Back to that pile of corporate cash. There's no question that it's a waste today. But today's waste is tomorrow's potential. 

Corporations aren't going to sit on that cash forever. Eventually conditions will be such that they'll either want to or have to invest in new projects.

Perhaps inflation will be the catalyst – corporations can tolerate losing 1.7% per year today. But if the inflation rate heats up to, say, 4%, you can bet that corps will be scrambling to deploy that now idle cash into whatever mediocre projects they can rustle up.

“When that happens, they have $1.4 trillion in cash ready to go. No need to negotiate a loan. No need to issue equity to raise funds. They have all the fuel they need. The gas tank is full.

So while the economy has plenty of problems, and stocks are a far better bet than bonds, lack of cash is not one of them.

Companies are ready to invest and grow. They just need an economic and political environment conducive to doing so.

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Reader Comments (5)

Sounds so rosy. If inflation rises to 4%, monetary velocity will indeed accelerate substantially, as this piece argues. Cash will become a hot potato. This, in turn, will feed further inflation. At this point, the Fed would have to massively disgorge its balance sheet to maintain any semblence of control. The question is - how are they going to do that?
October 14, 2012 | Unregistered Commenterblankfiend
The current Fed, the way it seems to be going, might fight inflation with more QE. They're fighting all their imagined battles with QE. They're going to fight the flu with QE. Regardless of the consequences.
October 14, 2012 | Registered CommenterWolf Richter
In a few weeks Obama will be fired and companies will suddenly begin to spend that $1.4 trillion. Expect a Romney boomlet. Only temporary of course. Our fiscal condition is fatal.

Or. perhaps, the Kenyan TelePrompTer will win reelection. At that point thousands of small business owners will throw in the towel and liquidate. Expect another 2 million unemployed. The death spiral begins immediately.
October 15, 2012 | Unregistered CommenterJohn S
Problem is, companies will have to pay workers more money, and pick up a greater share of employee costs and benefits before employees can afford the products companies sell. Companies are anti-employee; therefor, a stalemate has ensued. Until entrepreneurs start new businesses based on taking better care of their employees, (yes, it CAN be done WITHOUT bankrupting the companies... look at all that cash they are sitting on that, 99% of was taken from the employees to begin with) We will CONTINUE a downward dive, and YES, a Romney victory would bring a short rally, but bottom line, if REGULAR Americans aren't making money, this world is going to descend into chaos... Thank the banksters, and the job exporting mega corporations (formerly American, now international) who will cut everyones throat to make a buck. And don't bother arguing with me. I'm right thats all there is to it.
October 16, 2012 | Unregistered CommenterDoug
Let us ask the question what is Fed really doing with QE? The Fed is "printing" free reserves NOT! The Fed is buying MBS and LONGER maturity treasury instruments. The Fed balance sheet becomes income gold and it is using investment income to reduce overall risk and increaseing yield and plans to hold to maturity. Any cash received by Banks is turned over to Fed at interest. The Bank is required by rule to keep QE funds on deposit at Fed. Our media is really socking it to us with poor reporting. QE IS DRAINING LIQUIDITY. Now about said " FISCAL CLIFF". The Bush tax breaks where extended by robbing the social security funding mechanism! So fiscal cliff is old people! The plan to enslave SURPRISE!
October 17, 2012 | Unregistered Commentertom kauser

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