Much has been made about the record amounts of cash that S&P 500 companies and corporations in general are holding onto, but few are talking about the record corporate debt.
According to the Federal Reserve, as of March 2012, U.S. non-financial corporations held a record $8.1 trillion in corporate debt. (Also see: “Bad Timing: Record Amount of Corporate Debt up for Refinance”). Returning to corporate cash-on-hand, the same Federal Reserve report shows that non-financial corporations held $1.7 trillion in cash at the end of March, down from $2.0 trillion last year.
Everyone wants those S&P 500 corporations to spend their record earnings to create jobs and thus spur economic growth. Investors in S&P 500 companies also want corporations to invest the money, because they certainly did not buy the shares just to earn interest in a bank account.
Despite these pressures, S&P 500 companies have bought back shares and increased dividends, instead of investing in capital projects, because they are uncertain that consumers will buy the products due to weak demand.
Yet, if S&P 500 corporations don’t create the jobs, consumers can’t buy products, and it’s the same old vicious circle.
The other side of this argument is the fact that corporations have record corporate debt and other problems they need the money for. A study from S&P Dow Jones Indices highlighted that, within the S&P 500, pension liabilities were under-funded by a record $354.7 billion at the end of 2011.
Because interest rates are so low, the S&P 500 companies can’t earn enough return to compensate for the payouts promised to pensioners, so their pension liabilities compound higher.
States and municipalities have the exact same problem, while savers in the U.S. economy can’t earn any money on their savings. (These are two prime examples of zero interest rate policies not working for the good of the economy!)
In total, S&P 500 companies set aside $1.96 trillion in cash in 2011 to pay for pensions and other employment benefits!
There is no question that more companies are shifting the burden of the pensions to the employees themselves, but legacy pension plans still exist and these deficits highlight how vulnerable S&P 500 companies are to a fall in earnings and how vulnerable pensioners are especially when they expect that check to come in every month.
Corporate balance sheets are not as healthy as they first look, with corporate debt and pension deficits a big problem. The best way to pay for this corporate debt is to invest the record cash on hand and generate a greater return on it in order to pay down the corporate debt and close the pension deficits.
However, S&P 500 companies have no confidence in the economy to generate a sufficient return on their money. The question is: why do investors still have confidence in the stock market when S&P 500 companies don’t?
Rome Burns; Europe Can’t Help
One of my favorite countries to visit, Italy, is in big trouble.
Just a few years ago, Italy’s government debt was roughly equal to its gross domestic product (GDP)—it had a debt-to-GDP ratio of about 100%. This is high, but Italy was able to maintain a budget surplus, which means after the bills were paid for the year, there was money left over from taxes the government took in to pay down government debt.
Like a household, the problem with holding high debt levels is that if something goes wrong, it can place the household in serious financial difficulties.
Enter the eurozone financial crisis and Italy’s government debt has now reached a debt-to-GDP level in excess of 120%!
To give some perspective to the problem, remember that the eurozone has been consumed by the problems of Greece, but Greece has government debt of 350