Tom Upchurch | April 2nd 2012 | @EG_Finance
It seems as if there is no end in sight for the age of austerity. If you thought it was only governments tightening their purse strings, then you would be very mistaken. Even before the financial crisis, companies throughout the US and Europe have been sitting on record breaking piles of cash. In the US corporate profits are higher than at any time in the past 65 years yet as a proportion of GDP, American business investment is at a 30 year low. Last year in the UK it is estimated that the corporate cash pile had reached over £700 billion. Perhaps most shockingly the global corporate cash mountain is predicted to be as large as $4.2 trillion!
Given the woeful condition of the OECD economies, these assets could play a significant role in fuelling economic growth. Whether it is through capital expenditure or M&A activity, financially active companies make active economies.
Despite this the corporate sector has shown a determination to hoard cash rather than invest it into the real economy. The roots of this risk aversion are, from the short-term perspective, easy to understand. The uncertainty surrounding the global economy and question marks over OECD markets in particular has induced a general sentiment of “wait and see”. Companies have been hesitating over making major investments in M&A and capital expenditure. Where they are seeing increasing opportunities is usually around emerging market expansion; a move which requires considerable capital in the coffers.
The financial system is also under significant regulatory and political pressure, with many losing confidence and faith in the system. Some of the biggest corporate treasuries have been saving so that they do not need to rely upon the banking system to finance operations. The late Steve Jobs had always insisted that Apple would retain their financial independence – a strategy which has led to the creation of the largest corporate cash mountain, totalling some $100 billion. Even Apple has come under pressure to do something with these reserves, hence the recent decision to pay a quarterly dividend and share buy back programme.
But at what point does this risk-averse attitude start to turn risky? If everyone is sitting on their money and refusing to actively invest into the economy, won’t this cause the economy to stagnate and return to recession?
Looking at Europe in particular, this scenario is not unimaginable. The UK Government has announced that it will take two years longer than it originally expected to eliminate the budget deficit. To achieve this belated goal will require massive fiscal tightening over the next few years. Other major European economies such as Italy, Spain and France face high budget deficits but with less time to pay back their debts. In short, any meaningful investment in the economy will not be coming from the public sector.
Given how cash rich the corporate sector is becoming, their future investment decisions could have major implications to the general economy. Clearly there exist significant opportunities for investment, and challenges surrounding how governments and companies will work together to make the best of these resources….more on this in future blogs!
It will be very interesting to see over the next few months whether a resolution to the Euro-sovereign debt crisis will boost corporate confidence and encourage more investment. The early signs are still fairly negative, with M&A activity in January the lowest it has been since 2003. For an accurate picture of the corporate mood, look out for our next Capital Confidence Barometer survey in a few weeks’ time.
What is clear is that over the coming year the corporate sector will be thinking hard about where they can get the best returns on their investment. They would also be wise to keep in mind the longer term impact of their prudence.