David Peartree, The Daily Record Newswire
Over the last several years, three investment ideas have been recycled time and again as a justification to be bullish on stocks.
We hear or read that “the market should go higher” because: 1) corporations are flush with cash they can spend, 2) corporate balance sheets are in great shape and 3) a “great rotation” is underway as investors shift from bonds into stocks.
These are not so much investment ideas as sales pitches. They serve as a reminder that much of what is said about the markets and investing amounts to noise, something to be filtered out and ignored.
Corporate cash will fuel investment spending. The assumption here is that the large amounts of cash on corporate balance sheets represents fuel for capital expenditures on jobs, plant, equipment and technology that will fuel of cycle of growth, higher employment, and increasing profits.
This argument has been in circulation since at least 2011. In October of last year, The Wall Street Journal reported that U.S. nonfinancial corporations held about $1.5 trillion in cash, up over 80 percent from the $820 billion held at the end of 2006. Reuters reported that corporations globally held nearly $7 trillion of cash as of the end of 2013, more than twice the cash held 10 years prior.
One major problem is that much of this cash sits overseas and will likely stay there. As much as 60 percent of the cash reported on the balance sheets of U.S. corporations sits in overseas accounts. Corporations don’t want to deal with the repatriation of that cash and face corporate tax rates as high as 35 percent, among the highest in the global economy.
Greater investment by corporations would certainly be a boost to the economy, but investors should not assume that cash held by corporations will necessarily lead to more spending, stronger economic performance, and better investment returns, at least not in the short term.
Corporate balance sheets are in great shape. This statement is related to the observation regarding large cash balances. The statement is often framed in the superlative: corporate balance sheets are in the “best shape in decades.”
Corporate finances certainly appear to be in good shape but the case may be overstated. It is true that corporations hold large cash balances. They also hold high levels of debt, a point often overlooked.
As of late 2013, U.S. nonfinancial corporations held over $9 trillion of credit market debt. This is $2 trillion more debt than they held at the end of 2007. Moreover, corporate debt as a percentage of the total net worth of U.S. nonfinancial corporations has increased significantly since 2007. Debt now equals about 48 percent of total net worth, up from only about 38 percent at the start of 2007.
Over the past several years U.S. corporations have refinanced debt to take advantage of lower interest rates, but they have also increased their overall debt load. Corporations may be in good shape overall, but the implications for investors are probably overstated.
The “Great Rotation:” This was the opening investment theme for 2013. The argument was that in the aggregate individual investors would dump bonds, buy stocks, and propel the market higher.
2013 was, in fact, a great year for stocks, but it’s hard to attribute this to any investment rotation from bonds into stocks. Fund flow data for mutual funds is a reasonably good proxy for how retail investors are shifting their dollars.
Net inflows into stocks were strong last year but close to 90 percent of the inflows were into international stock funds. U.S. stock funds actually experienced outflows in six months and overall inflows were light.
It turned out that U.S. stocks where net inflows were light had a much better year than international stocks where inflows were heavy. The facts don’t fit the narrative.
Bonds did experience net outflows last year but mostly in the municipal bond market which struggled the most last year. Bond funds actually experienced consistent inflows for the first five months of the year, a period during which the stock market was performing solidly.
The facts don’t support the narrative of a rotation from bonds into stocks pushing the market higher.
As investment ideas go, the ideas that high levels of corporate cash, strong corporate balance sheets and a rotation from bonds to stocks will push the market higher are simply tired. Where the market goes from here is anyone’s guess, and these three ideas offer no justification for deviating from one’s strategic asset allocation.
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David Peartree, JD, CFP is the principal of Worth Considering, Inc., a registered investment advisor offering fee-only investment and financial advice to individuals and families. Offices are located at 160 Linden Oaks, Rochester, NY 14625; email david@worthconsidering.com.
