Fisher Investments Editorial Staff
Others

Cash Is Cheap

By, 08/04/2010

Story Highlights:

  • Firms successfully raised $90.1 billion in July alone, with an average yield of 5.01%—an amount not matched since 1999 at the lowest rate since 2004.
  • Unless current dour appraisals of economic health prove true (unlikely in our view), the corporate bond binge is hugely encouraging.
  • Businesses holding record levels of cash are wisely building those piles higher by leveraging them at today's low rates.
  • We may see the steady deployment of corporate cash continue to bolster business spending—but also go toward mergers and share buybacks.

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(Editor's Note: MarketMinder does NOT recommend individual securities; the below is simply an example of a broader theme we wish to highlight.)

 

The first half of 2010 has been dominated by questions lacking immediate answers: Will Europe disintegrate, will financial regulation cripple capital markets, will Brett Favre finally retire? Investors, businesses, and sports fans alike have grappled with plenty of ambiguity, and maybe that's why private firms are finding such a huge, cheap market for their debt. Indeed, only the latest in a lengthening line of firms to offer bonds at ultra-low rates, IBM sold $1.5 billion worth of 3-year notes for 1% on Tuesday. US firms successfully raised $90.1 billion in July alone, with an average yield of 5.01%—an amount not matched since 1999 at the lowest rate since 2004.

 

Investors may be betting deflation's on the way (making future interest payments more valuable) or they may be seeking the perceived safety of fixed income plus a little extra to top Treasuries. But unless current dour appraisals of economic health prove true (unlikely in our view), the corporate bond binge is hugely encouraging. For all the talk of broken credit markets, corporate bond sales show credit is amply available for the creditworthy. And investors don't accept ultra-low rates unless they're confident corporations are healthy and low-risk. Indeed, balance sheets are solid, costs under control, and profits up hugely.

 

Businesses holding record levels of cash are wisely building those piles higher by leveraging them at today's ultra-low rates. Firms may be a little conservative at the moment, but they aren't borrowing money to sit on it and pay interest. They expect investment in future economic growth will yield a return at least above what they're paying to borrow—and likely quite a bit more. One metric shows this clearly—the earnings yield on global stocks is 8.2%—much higher than today's borrowing costs for highly rated companies.* Said another way, firms can borrow funds on the cheap, reinvest them in new business investment opportunities, mergers, or share buybacks and reap a rich reward.

 

Private firms are leading the economy higher (business spending was up +28.8% adding 3.1% to US GDP in Q2) while simultaneously building cash balances and battling a ton of uncertainty. Notoriously fickle Brett Favre may keep fans on pins and needles for a little while longer, but other more material factors (for investors) are being put to bed. An abnormally active legislative cycle, sovereign debt crisis, European bank stress tests, global bank reform, and US congressional elections are all (or soon to be) in the rearview mirror.

As uncertainty eases, we should see the steady deployment of corporate cash continue to bolster business spending—but also go toward mergers and share buybacks. These are likely to be a few key bullish forces moving the economy and stocks along recovery's path.

 

* Thomson Reuters, Bloomberg Finance, L.P.; as of 6/30/2010

*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.

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