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Digging Into Corporate Balance Sheets

Conclusions:  Broadly speaking cash on corporate balance sheet is up, though not meaningfully since 2008.  Moreover, with low risk-free rate of return, cash balances are actually a drag on earnings growth.

Commonly, the health of corporate balance sheets is cited as a reason to be supportive of higher stock prices.  The theory is that as corporations build cash on their balance sheets it is both a sign of operational health and also provides ammunition to make acquisitions.  Therefore as balance sheets get healthier, there should be an underlying bid to equities due to increased M&A prospects.


We spent the weekend looking at the progression of corporate balance sheets for the 50 largest market capitalized companies in the SP500 as a proxy for the health of corporate balance sheets more generally.  Collectively, this group of companies is just over 50% of the total market capitalization of the SP500, so clearly a reasonable proxy for corporate America.


In this analysis, we also removed the financials, which for the largest 50 companies in the SP500 includes Citigroup, Goldman Sachs, Wells Fargo, J.P. Morgan and Bank of America.  The point is obviously not to understate the relevance of the balance sheets of banks, but rather to simplify the analysis and focus on operational cash and debt versus trying to decipher the balance sheets of the major banks and the nature of their cash and debt obligations.


In the chart below, we show the quarterly cash (short term investments and cash equivalents), debt (short and long term), and net debt balances of the largest 50 companies in the SP500 by market capitalization going back quarterly from June 30th2011 to June 30th, 2008.  In that time period, cash has grown by $273 billion, or +49%.   Over the same period, debt grew by +$78 billion.  In aggregate, corporate balance sheets, on this basis, have seen meaningful improvement since June 30th, 2008 as net debt has declined by almost -$200 billion over the period.


Digging Into Corporate Balance Sheets - dj 1


Interestingly, if we back out General Electric from this analysis, the growth of cash on corporate balance is less positive.  As the chart below shows, after removing GE, cash grew by over +$200BN from Q2 2008 to Q3 2011.  At the same time, debt grew by a comparable amount.  So on the basis of net debt as a proxy for health of the balance sheet, the largest 50 companies in the SP500, excluding the banks and GE, look almost exactly the same today as they did three years ago.


Digging Into Corporate Balance Sheets - dj 2


None of this is to say that corporate balance sheets are in poor health.  In fact, based on longer term historical studies, corporate balance sheets are quite healthy.  A recent study by the Wall Street Journal highlighted that:


“Cash accounted for 7.1% of all company assets, everything from buildings to bonds, the highest level since 1963.”  

That said, it is just not clear, that cash on balance sheets should be considered a positive catalyst for stock prices.


Conversely, it is somewhat disconcerting that cash is growing and not being invested, especially given the low interest rates that cash and short term investments are earning.  In Q3 2008, the 90-day money market rate was roughly 3% versus roughly 0.4% now.  As a result of declining rates, the change in interest income on an annualized basis from Q2 2008 to Q2 2011 was a decline more than -$13 billion from $16 billion to just over $3 billion.  So, while cash balances growing are a positive, the decline in the return on cash has more than offset that positive.


Finally, in the two charts below we show the most improved balance sheet over the last three years and the worst performing balance sheet, all on the basis of growth of net debt.  As mentioned above, GE appears to have a dramatically improved balance sheet from (disclaimer: we have not done a deep dive on GE) three years ago, while on the negative side, Exxon Mobil has seen its balance sheet decline over that period going from $30.1BN in net cast to $6.5BN in net debt.


Digging Into Corporate Balance Sheets - dj3


Digging Into Corporate Balance Sheets - dj4


Clearly, corporate balance sheets in the U.S. are in decent shape, but we would caution against using that as a market catalyst.  Arguably, as well, it is actually a drag on earnings growth as long as cash sits on the balance sheet unproductively earning low rates of return.  In fact, by letting cash sit and earn low rates of return, corporations are actually signaling that they do not see meaningful growth opportunities in the future.


Cash is king . . . if it earns a return.


Daryl G. Jones

Director of Research

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European Risk Monitor: No Magic Wand

Positions in Europe:  Short EUR-USD (FXE); Cover Italy (EWI) today

The magical European Bazooka Wand didn’t come out this weekend, and we don’t expect to see it at the EU-Summit on October 23rd either. Eurocrats have much on their plate, including bank recapitalization procedures, expanding the EFSF, and broader measures to insulate risks to the PIIGS.  At odds remains the ECB’s unwillingness to take on more exposure, either directly through the EFSF or its bond purchasing program (SMP), and indecision from Eurocrats (and IMF) on Greek debt haircuts (21% vs likely reality of 50-60%), Eurobonds, higher capital standards for banks (including for future stress tests), and member nation default.


The European bag of risk continues to be directed by headlines, most particularly by the expectations that the “next” Eurocrat meeting will bring a positive solution to the region’s ills. Here we’ll repeat our bearish outlook on European capital markets. We think any relief rallies over the immediate term will be short lived, including for the EUR/USD – Europe has structural long term issues that will not be solved with the snap of a finger. We would however point to the November 4th G20 meeting as a likely date for additional direction to the banking and sovereign crisis. Quantifying last week’s bounce, European equity indices rose between +4 to 6% and the EUR-USD cross gained +3.8%.


In this light, we remain short the EUR/USD and find it prudent to be short select markets or on the sidelines until the details of Big Bazooka are revealed. The EUR/USD continues to be broken on its intermediate term TREND ($1.43) and long term TAIL ($1.39).  Today Keith tactically covered our short position in Italy (EWI) in the Hedgeye Virtual Portfolio, however longer term we remain bearish on Italy. It was just Friday that Berlusconi won a narrow confidence vote, demonstrating just how fragile his rule remains, which creates huge political headwinds as the market judges the broader Italian economy on his ability to secure budget cuts in the coming 1-3 years.


Below we show our typical Monday risk monitor charts. Of note is that Italian yields (currently at 5.78%) are creeping dangerous close to the 6% level, a historically significant break-out line for Greece, Ireland, and Portugal, and the spread between German bunds and the 10YR French yield is at a decade wide of 95bps today. As we've said before, a downgrade of France's AAA credit rating is a real possibility that would have disastrous effects across the region, including undermining the EFSF.  


A look at sovereign cds shows that Irish, Spanish, Italian and French spreads were slightly wider week over week, while Portuguese and German spreads tightened week over week. In particular, German CDS tightened by 8.9% (see charts below).


European Risk Monitor: No Magic Wand - 1. hm yields


European Risk Monitor: No Magic Wand - 1. josh cds1


European Risk Monitor: No Magic Wand - 1. josh cds2


Finally, our European Financials CDS Monitor showed that bank swaps mostly tightened in Europe last week.  Swaps tightened for 37 of the 40 reference entities. The average tightening was 7.2%, or 36 basis points, and the median tightening was 5.0%.  Spanish banks saw the least tightening of the group. 


European Risk Monitor: No Magic Wand - 1. josh banks


Matthew Hedrick

Senior Analyst

Bearish TREND: SP500 Levels, Refreshed

POSITIONS: Long Utilities (XLU), Short Consumer Staples (XLP)


Today’s failure at our intermediate-term TREND line of resistance is very consequential.


Across durations here are my refreshed levels that matter most: 

  1. TAIL = 1266
  2. TREND = 1231
  3. TRADE = 1189 

I don’t think failing at 1231 means we crash right here and now. What I have been saying about crashing stock and commodity prices (20% declines from YTD peaks) is that the probability of crashes occurring goes up as market prices do (on low volume and negative skew).


If 1189 (TRADE support) holds, that will be a healthy signal in the immediate-term. If it doesn’t, it will be another bearish one. This is why earnings season hasn’t been this important in years.


In the very short-term, earnings should help take some of the headline burden off of European sovereign risks. The problem with that is that earnings like JPM and WFC have been negative catalysts too.




Keith R. McCullough
Chief Executive Officer


Bearish TREND: SP500 Levels, Refreshed - SPX

H&M: Lower Highs, Lower Lows

Not a good nugget related to the strength of the global consumer.


September comps -7% showing a sequential slowdown on both a 1 and 2-year basis. With few exceptions, the trendline since August 2010 has been heading lower. The key here is that H&M is ‘comping the comp’ with relatively lousy numbers. So for all those people who think that after 1-year things must start to get better, they might want to tack on another 10 months to their ‘process’.


In typical UK fashion, disclosure is horrible, so until the mid-November report,  all we know is the comp, and don’t know what countries or products are driving the business (or not, for that matter). The interesting thing we always keep in mind with H&M is that its geographic dispersion is simply massive, and sells everything from fast fashion apparel, to high-end Champagne, to cosmetics, and more. In other words, a fairly good barometer of the global consumer.


H&M: Lower Highs, Lower Lows - H M monthly sales 10 17 11


Here is H&M's sales distribution by country as well as the trends in the top 5 sales volume countries as of the September nine month report.


H&M: Lower Highs, Lower Lows - H M country dist. 10 17 11


H&M: Lower Highs, Lower Lows - HM top 5 countries