Many US companies have huge slugs of cash—$950 billion for the S&P 500.
Firms will eventually have to do something with the money—sitting on cash only nets a 0.25% return and will rankle shareholders looking for value creation.
As economic recovery continues and confidence rises, companies will deploy that cash toward a number of bullish outcomes.
Some say money buys happiness. We'd bet the S&P 500 firms believe it. With approximately $950 billion cash on hand (ex-Financials), close to 12% of the S&P's market cap is cold, hard cash these days.*
This is an older tale than you might imagine. Companies were cash-rich before the recession. Even during boom times of this decade, many firms (ex-Financials, of course) remained gun-shy from the tech boom and went through an era of unusual prudency—a "hunker-down" era, if you will—and scads of CEOs put off business investment. Even after the boom years of cash/debt merger activity in 2005, 2006, and 2007, overall debt remained low and cash high.
That cautiousness revved up as the recession hit. When companies saw an economic downturn in the fore, hunker down went into high gear—firms slashed inventories, shuttered factories, lowered headcount, etc. The already lean and mean got leaner and meaner.
As a result, firms have the strongest balance sheets (again, ex-Financials) in memory, which sets the stage for future investments on technology upgrades, R&D, infrastructure spending, mergers and acquisitions, dividends, etc.—all good for stocks and the economy.
Why's this so important? Because the biggest hit to the economy wasn't consumer spending (though many believe so) it was business investment and trade activity. With so much cash in waiting and a steeper yield curve than we've seen in decades, the stage is set for companies to start growing—bigger and faster than many realize. That will be the heart of the rebound.
But what's the catalyst? Or, said another way, if the conditions are there, why isn't the big boom happening now? Mostly, it's a confidence issue. Folks are still a bit gun shy. One of Milton Friedman's best and longest lasting insights is that when looking at the yield curve and monetary policy generally, the effect on the economy is likely at least 6 to 12 months out—that is, a bit delayed. That wisdom probably applies to the conditions of aggregate business investment as well. Once some confidence returns (which has been steadily increasing so far this year), the aggregate activity will eventually follow. And as we've said repeatedly in this space, stocks always look ahead—discounting the future now. That makes for happier times for stocks in the here and now.
The pick-up will happen sooner or later because—and here is one of the many great virtues of free market capitalism—shareholders will demand it. CEOs sitting on dough yielding less than a percent is not an attractive place for capital looking for historical stock-like returns. If executives don't ultimately deploy their capital and grow—deliver shareholder value of some kind—investors will find someone else who will.
Want even more cash-induced glee? Right now, firms are running so lean, just a slight uptick in revenues is likely to create outsized earnings gains (i.e., operating leverage).
A few other features to consider: Lean inventories will force companies to restock as demand picks up along with the economic recovery. Already, economic data shows a pick-up in the manufacturing sector and new orders in particular. Second, conditions are ripe for spending. The recession has brought about discounts and opportunities firms can take advantage of. Exxon's recent $31 billion purchase of XTO is simultaneously a show of the huge cash reserves companies have to deploy and credit-worthy companies' ability to raise capital as needed even after last year's tumult. Further, it indicates a belief energy usage will be robust and more expensive in the future—in other words, optimism the global economy is on the mend.
Cash may make you feel wealthy, but bigger earnings on the wings of that cash are ultimately the royal road to riches for equities. As negative sentiment subsides and companies become less risk-averse, cash will be deployed in a big way globally—a good thing for stocks and the economy, and more happiness for all.
*Thomson Reuters, Standard & Poor's, Global Industry Classification, Worldscope; as of 09/30/2009.