Monday, October 4, 2010

Awash in Cash and Profits, Corporate America Keeps Borrowing

As dismal as much of the recent economic news has been (especially for the consumer) corporations are actually not faring too badly. True, top line growth (i.e. sale) has been flat but margins remain healthy and, if anything, are expanding.

By ruthlessly cutting costs, moving production overseas, and using the Internet to improve production, earnings for many sectors in the economy have been pretty decent.

We won't know for a couple of weeks, of course, whether the third quarter will be as good as expectations, but it seems at this point that company profits will be O.K.

Here's a story from this morning's Wall Street Journal discussing this:

U.S. companies are rebounding quickly from the recession and posting near-historic profits, the result of aggressively re-tooling their operations to cope with lower revenue and an uncertain outlook.

An analysis by The Wall Street Journal found that companies in the Standard & Poor's 500-stock index posted second-quarter profits of $189 billion, up 38% from a year earlier and their sixth-highest quarterly total ever, without adjustment for inflation.

As companies begin reporting results for the third quarter, just ended, the strong growth is expected to continue, albeit at a slower pace, S&P said.

At the same time, corporations have been issuing records amount of debt, but simply hoarding the cash rather than investing in plant and equipment, or hiring new workers.

This is the quandary the Fed finds itself in; in cutting interest rates to historic low levels, the Fed is trying to spur job growth. Unfortunately, all that seems to be happening now is corporations are borrowing the money but holding onto the cash.

Moreover, while many homeowners are refinancing their existing mortgages (assuming they have equity in their homes), sales of new or existing homes has turned sluggish again, after the expiration of the tax credit incentives.

Here's an excerpt from an article in yesterday's New York Times:

Corporations keep saving, waiting for the economy to perk up — but the economy is unlikely to perk up if corporations keep saving.

This situation underscores the limits of Washington policy makers’ power to stimulate the economy. The Federal Reserve has held official interest rates near zero for almost two years, which allows corporations to sell bonds with only slightly higher returns — even below 1 percent. But most companies are not doing what the easy monetary policy was intended to get them to do: invest and create jobs.

Companies Borrow at Low Rates, but Don’t Spend -