Daily Gains Letter

Why Corporations Aren’t Investing in the Economy—Again

By for Daily Gains Letter |

Why Corporations Aren’t Investing in the Economy—Again

Revenues are coming in light, but earnings are holding up.

Now that it’s the heart of earnings season, it’s a good time to reevaluate portfolios for risk.

There is still a lot that could go wrong in this market, and there is no help from the rest of the world in terms of economic growth.

Also evidenced by this earnings season is the continuing buildup corporations have in terms of cash. What this signals to me is that corporations are still very nervous about making major new investments, which is holding the U.S. economy back.

Getting corporations to invest in new businesses, plant and equipment, and new employees requires certainty. And this is the one thing that is lacking in so many important markets for the simple reason that there is too much debt.

There are actually a lot of fundamentals that are positive for corporations. Interest rates are very low, so borrowing costs have never been more favorable for big companies.

There is some price inflation in the economy, which translates to higher earnings, and because of the weakness in commodity prices, the cost of raw materials is going down.

But large corporations are not going to invest in major new operations in markets where there is the potential for massive instability—currency instability, for sure.

So the result is just the status quo for many corporations in terms of their business operations. This is why cash balances continue to build and share buybacks are so common.

I would say that given the earnings results so far, the stock market is not overvalued. If there isn’t any meaningful revenue growth soon, however, the lack of earnings growth will definitely make the stock market look expensive.

It is difficult to imagine corporations being able to squeeze out more productivity than they already have; cost controls have been in place for years now since the financial crisis.

From the investor’s point of view, strong balance sheets are always attractive. But the lack of growth in revenues, with the stock market trading close to its all-time record high, makes being a new buyer very difficult.

One industry that has perfectly illustrated slow to no top-line growth while maintaining earnings is the railroad stocks. These corporations are holding strong, but there’s very little growth.

Union Pacific Corporation (NYSE/UNP) reported good earnings results and revenues that beat the Street, but the other major railroads only reported flat business conditions.

There has been growth with more consumer-oriented corporations, like PepsiCo, Inc. (NYSE/PEP), NIKE, Inc. (NYSE/NKE), and Johnson & Johnson (NYSE/JNJ), for example. But so far, these companies are the exception.

Corporations have strong balance sheets, and that’s a good foundation for the future. The stock market is due for a significant correction, and it should be a buying opportunity.

But by next earnings season, corporations will have to show growth in both revenues and earnings. If they don’t, then this market will be in real trouble.

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  • Frank Beran

    Time to devalue the Dollar then.