Consumers were the Achilles’ heel of the U.S. economy in the run-up to the last recession. This time, companies may play that role.
Among the warning signs: rising debt, lagging profits and mounting defaults. While the financial vulnerabilities aren’t likely to lead to another downturn soon, economists say they point to potential potholes down the road for an expansion that’s approaching its seventh birthday.
“Companies have been adding to their debt and their debt has been growing more rapidly than their profits,” said John Lonski, chief economist of Moody’s Capital Markets Research Group in New York. “That imbalance in the past has usually led to problems” in the economy as companies cut back on spending and hiring.
Case in point: Last week’s news that so-called core capital goods bookings fell for the third straight month in April. The seasonally-adjusted total of $62.4 billion for non-defense orders excluding aircraft was the lowest in five years, prompting Neil Dutta of Renaissance Macro Research to label business investment “pathetic.”
The similarities between the pre-recession debt binge by consumers and today’s burst of borrowing by companies are striking. Like households, corporations are using the money for short-term purposes rather to prepare themselves for the future. They’re basing their bets on rosy expectations that may not pan out. And it’s the bottom 99 percent that are most at risk should credit conditions tighten.
While corporations as a whole possess a record $1.84 trillion of cash and liquid investments, it’s heavily concentrated among a small number of companies, mainly in the technology sector, according to a study this month by S&P Global Ratings analysts Andrew Chang and David C. Tesher.
The rich are getting richer as companies such as Apple Inc. and Microsoft Corp. add to their cash hoards, they wrote in their report.
Take away the $945 billion the 25 richest companies rated by S&P hold, and the picture doesn’t look particularly pretty for the bottom 99 percent of non-financial corporations. In fact, their cash-to-debt ratios are at their lowest levels in a decade, according to S&P. And more than 50 U.S. companies have defaulted on their debt so far this year.
Behind the deterioration in creditworthiness: surging corporate borrowing. Enticed by record-low interest rates, companies increased total debt by $2.81 trillion over the past five years to a record $6.64 trillion. In 2015 alone, liabilities jumped by $850 billion, 50 times the increase in cash by S&P’s reckoning.
For the most part, companies aren’t pouring all that money into capital expenditures to increase the efficiency and capacity of their operations. Instead, much of it has been used to finance share buybacks, dividend boosts and acquisitions.
Since 2009, S&P 500 companies have spent more than $2 trillion to repurchase shares, helping sustain a rally where stock prices almost tripled. Mergers and acquisitions worldwide, meanwhile, jumped about 28 percent last year to a record $3.52 trillion, according to data compiled by Bloomberg.
“If you put yourself in the seat of someone responsible for management of a company, they see weak demand,” Federal Reserve Governor Jerome Powell said in a May 26 appearance at the Peterson Institute for International Economics in Washington. “They can cut costs and they can buy back their stock and they can make their numbers that way for a period of time.”
Now, both buybacks and takeovers are starting to tail off as companies increasingly feel the pinch from sagging profits. S&P 500 earnings from continuing operations fell 7.1 percent in the first quarter from a year earlier, data compiled by Bloomberg as of May 27 show. Even after stripping out energy companies hit hard by weak oil prices, earnings were still off by 1.5 percent.
“There is newly intensified, broad-based pressure on business to cut capital spending and inventories,” David Levy, chairman of consultant Jerome Levy Forecasting Center LLC in Mount Kisco, New York, wrote in a report to clients this month.
Earnings are being squeezed by lagging worker productivity and mounting labor costs as the tightening job market forces companies to pay employees more.
Corporations also are confronting downsized economic-growth expectations. Richmond Federal Reserve Bank President Jeffrey Lacker told Bloomberg News this month that he now pegs the potential growth rate of the U.S. economy at 1.5 percent. That’s half the average pace in the quarter century that preceded the December 2007 start of the last recession.
It’s not only the U.S. where GDP is lagging. “We are seeing a slowdown in emerging and developing countries as well, and it looks increasingly likely that long-run, or potential, growth has fallen,” David Lipton, the International Monetary Fund’s No. 2 official, said at the Peterson Institute on May 24.
Lonski of Moody’s said it’s premature to predict that the U.S. is heading into a recession because the labor market is still strong. But the squeeze on companies is “a risk factor that’s worth watching.”