The Three Charts Of The Corporate Apocalypse (Or Why Aren't Low Rates Working?)
Corporates are in relatively good financial shape and theory says should respond to high profits and cheap debt by investing more. However, while high 'profits' and low cost of debt are reasons for capex and opex to be rising more quickly than they are, these two critical drives of recovery show no signs of responding to these profit/debt incentives - and so as Citigroup notes "recovering is not booming". Top-down, compared to history, capex is low, following P/E's sentiment - especially in Europe (indicating a lack of confidence in the future). However, at the sector level this reverses: high capex has been given a low PE, while low capex has a high PE. The market is effectively encouraging companies to invest less and return more money. Longer term the consequences for economic growth, inflation and earnings growth are negative. It seems - as indicated by the relatively low level of net borrowing during a period of ultra-low interest rates and the market's decision to demand low capex and more yield from companies - that the balance-sheet-recession mantra of debt-minimization over profit-maximization is in full swing in the corporatocracy - and we know from Japan that no matter how much extreme monetary policy is thrown at the wall, none of it sticks.
The Lower The Rate, The Less They Borrow
Despite extremely low interest rates around the world's advanced economies - and lots of chatter of high levels of new issuance, the fact of the matter is that net new issuance (i.e. new-issues - redemptions/maturies/coupons) has remained low to negative (one of the key reasons for credit's strength as the supply drag remains light). This is entirely paradoxical to the central-bankers' mantra of reducing rates to spark releveraging and growth...
Confidence Versus Capex
There is a close relationship between P/E multiples and capex over the last 20 years. Companies invest more when they are confident about the future. They get that confidence from the market’s confidence in their growth prospects, as shown by a higher P/E. As the P/E has fallen, capex/sales has declined. This lower level of investment is likely to have an impact on the ability of companies to grow and also on the growth rates of the economies in which this spend has been reduced.
Save - Or Be De-Rated
The chart below shows the relationship between the level of 2012 capex/sales and the P/E. Unlike market history those companies that are spending relatively high levels of capex are now on low P/Es. Those sectors with lower capex/sales ratios are being rated more highly. The equity market is saying to those companies that invest heavily in capex that it would rather they didn’t.
The equity market is clearly skeptical about the value created by high levels of capital spending.
Bottom-Line:High profits and low cost of debt are reasons for capex and opex to be rising more quickly than they are. Compared to history capex is low, following the PE. However, at the sector level this reverses. High capex means a low PE, while low capex means a high PE. The market is effectively encouraging companies to invest less and return more money. Longer term the consequences for economic growth, inflation and earnings growth are clearly negative - as we trade (once again) short-term equity gain for long-term sustainable economic gain.
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