What are companies going to do with their abundant capital? The answer to that question will determine much about the medium term future of global stock markets. Much has been made of the two speed global economy, with the developed world struggling and the developing world growing fast. But there is another two speed system, partly because of the privatisation of profits and the socialisation of losses. Big companies have plenty of equity and can usually raise debt cheaply, while governments have the opposite: not enough capital, and a high probability they will start paying a lot more for their borrowing very soon. Some of the weaker governments already are.
A Mercer report summed it up thus: “The status of sovereign debt as a safe haven investment has been put into question. In a world where the cost of borrowing for Microsoft is cheaper than the cost of borrowing for many sovereign developed countries, the whole approach to bond investing may need to be revisited.”
In many ways, big business, as opposed to big finance, was well prepared for the global financial crisis. Business around the world went into the meltdown with relatively low gearing, unlike the 1990 and 2000 economic downturns. Though demand collapsed during the crisis period, there were very few corporate (as opposed bank) failures. American corporate savings and balance sheets remain very solid. There is now almost $US2 trillion in cash balances in the US top 100 companies alone, with R & D and innovation projects also picking up.
Australian big business was also quite well prepared, and for many that weren’t, such as Wesfarmers and Rio, there was always the post-GFC lazy capital raising bonanza (more than $100 billion) to paper over any problems. Citigroup was predicting at the beginning of the year that there would be a spate of M&As as companies looked to spend their extra capital. So far, it has not happened.
The big question for markets is what will the big companies will do with their capital? In America, the fate of that $2 trillion will be critical for any recovery in employment and economic growth. The hope is that it will be invested in American jobs, but it may just as easily go into Vietnamese or Eastern European jobs.
In Australia, the cartels are being pressured to return capital, which is not entirely a bad idea given their dismal record at globalization and their limited options in acquiring fellow members of the cartel club. Following the money will be very instructive for investors.