Markets Insight

April 9, 2015 8:42 am

Corporate cash cows drive out investment bulls

Ralph Atkins in London

Concern grows at lack of corporate capital expenditure in QE era

What keeps central bankers awake at night? Maybe it is the fear that company chief executives are ignoring their extraordinary efforts to kick-start economies.
Low levels of business investment since the collapse of Lehman Brothers are a growing concern in 2015. For central bankers, the worry is that rather than reviving Keynesian “animal spirits”, exceptional monetary policy actions have actually hampered markets’ basic function of financing the expansion of economies.

For equity investors, the danger is that surging stock markets have been far too optimistic about growth prospects — and reward those chief executives who hand money back to shareholders rather than those with ambitious, job-creating expansion plans.

This week the International Monetary Fund warned that the post-2007 financial crises could have permanently lowered the rate at which economies can expand. Yet on the same day, the IMF provided some comfort for insomniac policymakers and nervous investors in a separate analysis of why private investment fell 25 per cent in advanced economies during 2008 to 2014, compared with forecasts made in early 2007.
Rather than suggesting something had gone profoundly wrong with financial markets, the IMF argued the fall could be explained simply as the result of exceptionally weak economic growth. Some negative effects were identified as resulting from high economic uncertainty and weakened banking systems, for instance in southern Europe. Even then, however, the behaviour of companies was not particularly abnormal.

What was more, the IMF argued that the current “disconnect” between high share prices and poor real economic growth was not exceptional.

Textbook economics would suggest that strong stock markets — the FTSE All World share index is up 150 per cent since early 2009 — should have encouraged an investment boom; with demand for their shares strong, companies should have little problem financing expansion plans.

That has clearly not happened, but the IMF analysis maintained that the weak relationship between market valuations and capital spending was not unusual.

Striking an even more positive tone, the IMF argued stock markets could instead be leading indicators of future investment trends. “If stocks remain buoyant, investment could eventually pick up,” it concluded optimistically.

The implications of the IMF’s research are clear: structural weaknesses in economies should be addressed but QE should be given time to work, with central bankers taking care to prevent a premature rise in real interest rates.

For those who have waited patiently for a pick-up in investment, the IMF’s stance might seem far too complacent. It does not discuss what caused output to weaken in the first place beyond noting that “this weakness itself is due to many factors, including financial factors”. One significant financial factor was the collapse in the credit bubble, which prior to the crisis had fuelled unrealistic expectations about future economic growth.

Subsequently, investment spending has been curtailed against the backdrop of high debt levels.

If that is holding back investment, large injections of liquidity into the financial system via central bank “quantitative easing” are unlikely to make much difference.

Aggressive monetary policy will also have little impact if stock market incentives have changed in a way that discourages capital expenditure. Citigroup equity strategists argue that is exactly what has happened. They calculate that global listed companies cut investment by 6 per cent last year — as much as during the financial crisis years — while global dividend payments and share buybacks increased by 15 per cent. “For now, the market wants ‘cash cows’ not capex addicts. CEOs should take note,” a recent Citigroup note concluded.

With lower oil prices hitting investment by energy companies, the prospects for a pick-up are not great. The IMF’s view of the post-crisis world is obviously reassuring. Even if it does not herald a sudden improvement, it suggests business leaders are reacting normally and that investment will eventually rebound. But even if right, that could still mean stock markets have become badly disconnected from economic reality. The IMF only considered whether companies were being reasonable — not share markets.

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