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This arti­cle is a guest con­tri­bu­tion from Amer­i­can Cen­tury Invest­ments.

Mar­ket and stock ana­lysts have recently taken note of an inter­est­ing devel­op­ment that began in the depths of the Great Reces­sion. Just prior to its start (i.e. the third quar­ter of 2007), total liq­uid assets on the bal­ance sheets of non-farm, non-financial cor­po­ra­tions equaled $1.5 tril­lion and rep­re­sented 5.3% of total cor­po­rate assets. In the fourth quar­ter of 2008—one year after the reces­sion began and (in hind­sight, at its nadir)—liquid assets dipped to $1.4 tril­lion or 5.1% of total cor­po­rate assets. But in the five quar­ters since (through the first quar­ter of this year), total liq­uid assets increased dra­mat­i­cally to $1.8 tril­lion (an increase of $400 bil­lion) while liq­uid assets as a per­cent of total cor­po­rate assets—on a mar­ket value basis—increased from 5% to 7%.

That means that seven cents of every dol­lar of total cor­po­rate assets (the sum of the mar­ket value of its cap­i­tal struc­ture con­sist­ing of short– and long-term debt plus share­holder equity) is now invested in the equiv­a­lent of a cor­po­rate “piggy bank” as opposed to invest­ments in its long-term pro­duc­tive cap­i­tal (expected to earn a return in excess of a company’s cost of cap­i­tal). As the chart below illus­trates, while the long-term trend over 144 con­sec­u­tive quar­ters from the first quar­ter of 1973 to the fourth quar­ter of 2008 has been an increase in liq­uid assets as a per­cent of total cor­po­rate assets—increasing from 4% to 5% (see the dashed line labeled LT Trend)—the sud­den jump as the econ­omy emerged from a severe reces­sion is well above what the 35-year trend and five prior reces­sions would predict.

Notes:    (1) Liq­uid assets on cor­po­ra­tions’ bal­ance sheets con­sist of for­eign deposits; check­able deposits and cur­rency; time and sav­ings deposits; money mar­ket fund shares; com­mer­cial  paper;  Trea­sury, agency and GSE-backed and munic­i­pal secu­ri­ties; and mutual fund shares.

(2) Busi­ness assets are mea­sured at mar­ket value.

(3) Non-financial cor­po­ra­tions exclude banks, thrifts, mort­gage financ­ing cor­po­ra­tions where the pri­mary busi­ness is lend­ing money or extend­ing credit.

(4) “LT Trend” (Long-Term Trend line) illus­trates the lin­ear rate of growth for liq­uid assets as a per­cent of total busi­ness assets between the first quar­ter of 1973 and the fourth quar­ter of 2008 (144 quarters).

(5) Shaded areas rep­re­sent reces­sion­ary periods.

A Bull­ish Sign?

A num­ber of ana­lysts have con­cluded the sud­den increase in liq­uid assets on the bal­ance sheets of cor­po­ra­tions is a bull­ish sign for the equity mar­kets.  One ratio­nale is based on a pos­si­ble increase in cor­po­rate merg­ers and acqui­si­tions (M&A) activ­ity. His­tory has shown that cor­po­ra­tions with large amounts of cash will pur­sue acqui­si­tions, either of com­peti­tors or as exten­sions of their cor­po­rate strat­egy. With inter­est rates for prime cor­po­rate bor­row­ers at attrac­tive his­tor­i­cal rates and the cur­rent mod­est rates of over­all eco­nomic growth, the argu­ment for increase in M&A activ­ity as a means of growth is a per­sua­sive one. If a com­pany can’t achieve its long-term growth tar­gets via inter­nal growth, M&A (espe­cially acqui­si­tions) can become an attrac­tive alternative.

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