A good research piece from one of the Swiss banks this week suggests that market consensus is probably underestimating the tidal-wave balance sheet effect of the more than $1tn in globally generated after-tax corporate earnings per year.
Since the financial crisis, non-financial corporates have been de-leveraging balance sheets through an unprecedented accumulation of earnings, and a relatively conservative approach towards debt issuance. At the same time "cash outgoing" activities such as capex, M&A, buybacks and dividend pay-outs have failed to keep pace with the balance sheet cash build-up.
Since 2009, while total global non-financial corporate debt has increased, leverage (defined here as net debt to equity) has declined consistently to historical lows around the globe. What this means is that although the dollar value of debt has gone up, the rate of increase in the asset base (as a result of increased cash retention) has gone up faster, so that corporate leverage has actually declined.
In addition, the global low-rate environment has encouraged CFOs to take advantage of low interest rates to extend their corporate debt terms much further out, with the result that corporates are now net providers of short-term funding to the market.
1) market premiums will grow for an increased level of share buybacks and dividend pay-outs;
2) there will be a re-assessment of benchmark cost of capital calculations and market multiples, as long-term leverage ratio expectations get reset as cost of capital goes down, the market risk premium should decline to, justifying higher valuations overall);
3) even higher future premiums for corporates who have shown a disciplined approach towards value-accretive M&A and capital expenditure projects;
4) a decline in corporate credit spreads if low-leverage capital structures become the new norm; and
5) unused corporate funding or cash attracting a significant level of activism or governments looking to tax large pools of cash. Activist funds in the US have been particularly focused on this issue, with some success.
Our view is that this has been a long-standing theme and one which will remain so for some time, even if US interest rates start rising in the second half of 2015 (if that happens, we don't believe that it will be much more than a couple of token adjustment just to show that the Fed can...).
There are a couple of ways of playing this theme through ETF's that focus on companies that are part of buyback or high dividend paying indices. We already own those. We're also looking for the same in Japan, where the build up of cash continues to support this concept in the context of Japan's steadily improving earnings environment (Nikkei index constituents have just registered the ninth consecutive quarter of higher than expected earnings).
Steve & Justin
contact: +65 65577186
Find us on Facebook: http://www.facebook.com/JavelinWealth
Javelin Wealth Management supports the global microfinance philanthropy initiative www.kiva.org, the education charity, www.roomtoread.org, and the Singapore Children's Cancer Foundation, www.ccf.org.sg. New clients to the firm can nominate any or all of these charities for a donation we make on their behalf.