All my life I have enjoyed proving people wrong. It’s just the way I am. I think our country is like that, too…
In our last edition of Willingdon Views I identified two potential catalysts for the market. The first was, and continues to be, the hope that eventually the economic recovery will create jobs. Unfortunately, this has not happened yet as seen in the February employment report, which showed a decline of 36,000 jobs. The second potential catalyst was an increase in merger & acquisition activity. A recent report from research firm Sanford Bernstein predicted that M&A activity would increase 35% in 2010 vs. 2009. One source for this potential increase is the mountain of cash held by US corporations. According to Ernst & Young, Fortune 1000 companies have nearly $2 trillion of cash on hand, an increase of $271 billion over 2009.
Is cash really king?... Management has several options with which to deploy these bulging corporate coffers. First, they can buy back stock. In February alone there were 62 announced share buybacks, the highest monthly tally in nearly two years. Second, corporations can increase their dividend rates, and this is occurring as well. According to S&P, there were 79 dividend increases in the last three months and only two reductions. In the same quarter a year ago, dividend changes were much more balanced with 58 raised and 41 lowered. Third, management can use cash to make acquisitions, and the percentage of deals done with cash has increased from 40% in 2009 to 55% thus far in 2010.
More share buybacks, higher dividends, and increased M&A activity are all positive for stock prices. Moreover, I expect these trends to continue at least in the near term. Although the market has been acting better of late, it is still relatively flat for the year. Given strong earnings and these positive cash-related trends, why such a sluggish start for stock prices this year?
Coming to America?… Virtually the entire western world has a debt problem. The latest hotspot is Greece. Thankfully, there has been recent progress toward a coordinated bailout from the European Central Bank. Now the concerns have spread to Portugal, Spain, Italy, and Ireland. How far will it spread and will the debt crisis spotlight eventually focus on the U.S.? Ironically, in the near term, the worse things get in Europe the more the U.S. dollar as well as U.S. stocks and bonds tend to rally. This perceived flight to quality is perplexing to some and downright infuriating to others.
Niall Ferguson, noted columnist and author, made this statement in an article in the Financial Times – “Yet even a casual look at the fiscal position of the federal government (not to mention the states) makes a nonsense of the phrase “safe haven”. US government debt is a safe haven the way Pearl Harbor was a safe haven in 1941.” Is Ferguson correct or might he be full of nonsense?
Whether an economic Pearl Harbor awaits the U.S. depends largely on what we do to solve the debt crisis. Government monetary and fiscal policy, as well as private sector behavior in response to regulatory changes, will all play a key role in determining the economic future for our country.
Has there ever been a country that has proven more adept at rising to the occasion to overcome any challenge, no matter how formidable, than the United States of America? I think not. Despite the dire predictions from the likes of Mr. Ferguson and many other pundits, I believe the U.S. will rise to the occasion once again.
Two out of three ain’t bad… Solving our debt crisis is going to take a coordinated effort, as I previously mentioned. The good news is we are already working the process. In fact, two of the three major constituents have already made huge strides in this Great Deleveraging Cycle. First, corporations have been in austerity mode for some time, as evidenced by strong earnings, cash flow, and productivity. Eventually, this will translate into a pickup in hiring. Second, individuals have dramatically altered their spending patterns, moving from a negative savings rate to a positive savings rate over the last few years. Generally speaking, we have accepted the fact that the days when we can spend more than we earn are long gone. My sense is that this is a generational change in attitude and will not soon be reversed.
This leaves the third leg of the economic stool, affectionately known as the federal government. If I am correct in my long-held view that politicians ultimately follow the will of the people, they do not lead the people, then eventually the Great Deleveraging Cycle will shape the political process in Washington. Which, over time, will likely result in higher taxes, slower economic growth, and with a bit of wishful thinking, perhaps even less spending. Has any successful diet, physical or fiscal, ever been without some or even a lot of sacrifice and discomfort? I think not.
The U.S. as a society and economy is inherently competitive and entrepreneurial. We like to win and we have never been satisfied with being second rate at anything important. I don’t see that attitude changing. So, even though we may all have a layer of financial flab to lose, I am confident we will over time. We will because we have to, and we know this. Beyond that, we will get ourselves in financial shape because so many think we can’t. That is just the way we are.
Michael Kayes, CFA
