Lack of Investment by Corporations

August 23rd, 2016 by

recession3There are a number of troubling signs for the global economy: out-of-whack interest rates, rising geopolitical tensions, a corporate earnings slump. Overall, uncertainty reigns supreme around the markets, no matter where you look.

Even as the stock markets continue to reach all-time highs, the markets have not been kind to corporations so far this year. A stronger dollar has eaten into overseas earnings, which have already come under pressure each of the last two quarters. The current earnings slump is historically bad and would almost certainly signal a coming market correction, not a cause for stocks to rally.

Investors are simply complacent in trusting the Federal Reserve to keep propping up stocks with accommodative policies. Yet, businesses aren’t even taking advantage of those advantageous conditions, according to analysis by Credit Suisse.

Myopic Markets

With interest rates so abnormally low, and in many cases negative, credit has never been cheaper. Surprisingly, corporations have not taken advantage of the “easy money” like one would expect them to.

market-crashAn explanatory white paper recently published by Credit Suisse’s HOLT Corporate Advisory team “shows that corporate spending on both capital expenditures and R&D as a proportion of sales has been declining since the early 1990s.” This means that despite the incentives to do so, businesses are not borrowing for research and development; they’re not doing so for their capital infrastructure, either.

One factor in this trend is that many of today’s biggest companies are tied to internet services and no longer require huge capital outlays in order to grow. However, the emergence of Google, Facebook, and the like cannot account for this shift toward inaction in corporate investment.

looking-aheadWhether or not you believe that the future of corporate growth is optimistic or pessimistic,, this ought to be concerning news. It’s yet another example—along with excessive and unwarranted corporate stock buybacks, or “repurchase agreements”—of short-sighted corporate behavior. They are afraid to make any new investments amid uncertainty all around the world economy, but there’s also a real financial risk in standing pat when the opportunity for cheap financing exists.

Ashley Kindergan for The Financialist succinctly concludes:

“In the final analysis, investing is always a risk. Yet companies that don’t invest in capital expenditures or R&D are taking risks, too. Today, businesses have a unique opportunity to lock in ultra-low, long-term interest rates, and those that fail to do so risk being forced to borrow after rates have risen, thereby increasing the ultimate cost of financing. Firms that forego or postpone the kind of R&D and capital spending that paves the way for future growth may also find themselves with lower valuations than their peers, which could in turn lead to shareholder activism or even takeover threats. What’s more, by waiting for high-return investment opportunities that may never come in this increasingly low-yield, low-growth world, companies are at risk of allocating capital inefficiently, either by holding too much cash or returning too much to shareholders in the form of dividends and stock buybacks. There’s no denying that we live in uncertain times—but doing nothing is hardly a sure bet.”

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.

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