Corporate cash balances still growing - and so is debt

Corporate treasurers' risk tolerance remains low as they prefer to hold record amounts of cash on their balance sheets.

Source: JPMorgan

This is taking place at the time when companies have issued record amounts of debt to take advantage of ridiculously low rates. Increasingly however the proceeds of those bond sales and other borrowings sit in cash. The difference between total and net debt in the chart below is cash (above).

Source: JPMorgan

Markets are betting that some of this cash will ultimately turn into stock buybacks or dividends. Shareholders are certainly demanding it. Over time that will leave some of these firms more leveraged, and unless they "grow into" this debt, more vulnerable to downturns.

SoberLook.com

From our sponsor:

BOJ says party on - in the long run we are all dead

Japan's monetary experiment is truly unprecedented, both in size and scope. Not only is the overall central bank balance sheet growth accelerating, but the assets purchased are not just government securities.

Total Assets (source: BOJ)

The Bank of Japan is buying up REITs and stock ETFs to prop up both asset classes. The amounts are still relatively small, but the buildup is quite rapid.

BOJ's holdings of ETFs

BOJ's holdings of REITs

And with Keynesian economists cheering the BOJ on (see post), the policy is rapidly achieving the desired result. Japanese authorities are ecstatic - dollar-yen just broke 103 as the yen "printing presses" quickly debase the currency. Japan will quickly have a competitive advantage over South Korea, Germany, and in some cases even China. Japan's exporters are popping the Champagne corks ...

Yen per one dollar; source: Investing.com

The nation's stock market is now up over 75% over the past year as investors celebrate the massive stimulus, BOJ's direct purchases of ETS and REITs, and a rapidly depreciating yen.

Source: Ycharts

Japan's economy is quickly responding to this aggressive policy, with analysts frantically revising growth forecasts.

Goldman: - Strong Q1 growth, technical upward revision to our FY2013 forecast Jan-Mar real GDP growth came in at +3.5% qoq annualized, substantially outpacing the market consensus forecast of +2.7%. Consumption was the driver rising +3.7%, while exports turned positive for the first time in four quarters.

We raise our FY2013 real GDP forecast to 2.8% growth, from 2.5%, based on the strong GDP numbers for Jan-Mar.

The Bank of Japan's biggest achievement of course is pulling the nation out of the prolonged deflationary spiral. Market-implied inflation expectations have risen sharply over the past year, quickly approaching those in the United States.

5y inflation expectations (source: JPMorgan)

This is a great lesson for central banks around the world. If much needed structural changes fail or competitive pressures become too great, let you central bank resolve the situation. Just as the ECB "saved" the EMU with its OMT bond backstop policy, Japan is showing that highly aggressive central bank actions can work beautifully in the short term. But what happens in the long run some may ask? Don't worry about that, because as Keynes famously pointed out, "... this long run is a misleading guide to current affairs. In the long run we are all dead."

SoberLook.com

From our sponsor:

Fed's action won't influence deposit growth

A quote from an elevator mechanic in NYC: "You need to push the 'up' button to make the elevator come up. But pushing the button many times is not going to make the elevator move any faster."



We continue to receive emails pointing to what some have called "a broken monetary transmission" in the US. On the surface the argument looks compelling. The Fed's securities purchase program is expanding the monetary base - the amount of dollars in the system. In theory some of those extra dollars should encourage the banking system to extend more credit than it normally would, ultimately growing the broad money supply (M2 for example). But that's not how things turned out.

Unit = $ Billion

The argument goes that the banking system is broken and is unable to grow credit - which is being manifested as tepid growth in the broad money stock. Is that what's really going on here?

A closer look reveals that the slow growth in M2 is driven primarily by the leveling off in the amount of deposits in the US banking system (in the chart below the monthly fluctuations reflect the payroll cycle). Note that the spike at the end of last year is the "income harvesting" prior to higher tax expectations (see post).

Deposits in the US banking system (NSA, source: FRB)

But is this leveling off in deposits that unusual? How does it compare to changes in total deposit balances across US banks over longer periods? It turns out that the growth of deposits in the United States has actually been fairly steady - roughly 6.8% per year over the long run. The chart below shows a fit to 40 years of weekly deposit data.

While deposit growth fluctuated over time, it has maintained a steady growth trajectory. Recessions, market booms, Fed's policy, reserve requirements, etc. have had a relatively minor impact on deposit expansion in the long run (movement of money into equities and property in the early 90s had a bit of an inflection). And based on this fit, we are currently right about where we should be in terms of the overall deposit levels.

The assumption that the banking system can generate unlimited amounts of broad money simply because the banks have been injected with record levels of reserves is wrong. Banks' capacity to grow credit has always been limited, and it's no different this time. The "monetary transmission" is not broken - it is simply constrained.

The recent fluctuations are due to flows into stocks, mutual funds, short-term income funds (see post), etc. Deposits in the system will continue to grow at roughly 6.8% a year as they have done for the past 40 years, possibly longer.  Therefore the broad money supply - a great deal of which are deposits - will never keep up with recent unprecedented growth in the monetary base (which is up 18% YoY). The elevator "isn't going to move any faster".

SoberLook.com

From our sponsor:

EM-DM inflation rate divergence hits post-recession high

Emerging economies have always run higher inflation rates than developed markets (DM) due to stronger growth. The spread in inflation rates has generally been steady, running roughly 2-3 percentage points. Recently however the spread has blown out to over 4% - a post-recession high.

Emerging nations selling into developed markets are losing pricing power and will have a tougher time keeping up with domestic labor cost increases (some of which are forced by their governments). EM corporate margins are already under pressure, ultimately weakening growth. India or Mexico are good examples (charts below). While temporary, this divergence could be quite disruptive in the near-term.

Mexico GDP growth (source: GS)

SoberLook.com

From our sponsor:

Is the massive drop in lumber futures telling us something?

According to Nick Timiraos from the WSJ, the latest drop in the seasonally adjusted housing starts measure is nothing to worry about.

In fact he lists 4 reasons why this unexpected decline isn't in any way a sign of potential slowdown in the housing market.

WSJ: - Thursday’s housing report isn’t as much a signal that the sector is cooling—at least not until there are a few more of these reports—and instead a sign that the housing rebound isn’t going to unfold in a straight line

Perhaps. If we are not witnessing a cooling in new home construction, maybe Mr. Timiraos can explain why lumber futures have declined over 20% in the last couple of months. In April the explanation for the decline was related to cooler than usual weather conditions hampering construction. What happened in May? Some have rationalized this by the economic weakness in China. But the last time we checked a large chunk of this Globex-settled lumber still goes into new home construction - while the supply certainly hasn't changed. We look forward to hearing Mr. Timiraos' explanation.

July-2013 Random Length Lumber Futures (source: CME Group)

SoberLook.com

From our sponsor:

Why new CLO volume is declining?

CLO issuance in the US got off to a strong start this year. According to LCD, issuance averaged $1.9 billion per week in January and February. The volume however has declined sharply since then.

There are three key reasons for the decline.

1. Regulatory capital requirements for banks to hold AAA tranches is increasing (see this write-up for all the gory details). CLO managers tried to get their deals done prior to this change, pumping extra volume into the first couple months of the year.

 2. There simply aren't enough corporate loans to build a diversified collateral pool quickly enough. We don't see enough LBO deals to generate sufficient amount of new loans - the much anticipated Dell transaction for example didn't take place. And most companies who wanted to refinance, already did.

On the demand side, CLOs now face competition for loans from hedge funds, BDCs, and closed-end loan funds (see discussion). With few new loans for sale, a manager could end up with too much cash in the collateral portfolio. And you can't pay interest on liabilities with interest "earned" on cash.

 3. Finally, the interest earned on the collateral - even if you can get it - is too low. As the table below shows, the latest CLO deal still pays LIBOR+112bp on its AAA tranche.

Source: LCD

It's a bit lower than the 120bp spread on some earlier deals (see discussion) but is still pricey relative to the declining spreads on the collateral (chart below). The income received on the collateral less the expense paid on the liabilities (all the tranches) does not leave enough net "juice" for the equity to generate worth while returns. And as long as that dynamic is in place, it's going to be increasingly difficult to print new CLO deals.

SoberLook.com

From our sponsor:

Some of Eurozone's troubles can be traced to its paralyzed banking system

The news headlines out of Europe continue to surprise to the downside. Especially the euro area is struggling across the board, as growth in most countries stagnates.

Econoday: - Amongst the larger economies Germany managed a disappointingly small 0.1 percent quarterly advance but there were fresh falls in France (0.2 percent), Italy (0.5 percent) and Spain (0.5 percent). Neither the Italian nor Spanish economy has seen any growth since the second quarter of 2011.

Elsewhere performances were poor with quarterly expansion amongst those members supplying the data restricted to just Belgium (0.1 percent) and Slovakia (0.3 percent). There will be little surprise that Cyprus (minus 1.3 percent) was at the bottom of the growth table and there was renewed weakness too in the Netherlands (minus 0.1 percent), Portugal (minus 0.3 percent) and Finland (minus 0.1 percent). Estonia's good run also came to an abrupt halt (minus 1.0 percent) while Austrian activity was unchanged from the fourth quarter.

Some had hoped that as periphery nations begin to show trade surplus (due to declining domestic demand and lower labor costs), their economies may stabilize. But with global demand remaining weak in the first quarter and unemployment reaching new highs, that stabilization did not materialize. For now the periphery can not export its way out of recession.

Furthermore, the Eurozone periphery nations continue to struggle with what amounts to a paralyzed banking system with limited credit expansion capabilities. One key reason for this paralysis is a large (and growing) book of non-performing loans held by these nations' banks (unemployed borrowers and broke housing developers tend to have trouble making payments on their loans).

Non-performing loans as % of  total loans across the Euro area
(source: JPMorgan)

And just like in Japan in the 90s, not addressing the bad loan problem quickly generates prolonged periods of contraction. And that's how we end up with headlines like this:

SoberLook.com

From our sponsor:

Stocks decouple from "risk-on" indicators

The US equity market has decoupled from the overall "risk-on" complex. The chart below compares S&P500 with UBS E-TRACS Fisher-Gartman Risk-On ETN (ticker symbol "ONN" - see description here).

While the equity markets continued to march higher, other "risk-on" asset classes such as currencies and commodities have stumbled. The decoupling of the S&P500 index and the Australian Dollar (below) is a good example.

This is an indication that the market views large US companies (and other international firms) as being somewhat immune to weakness in global economic growth. Historically however that has not always been the case.

SoberLook.com

From our sponsor: