U.S. corporations have hearty cash flows. Consumers are inclined to keep spending. And European banks have the means to weather a sovereign debt default, according MFS Investment Management.
Those are the makings of a sustainable global and domestic economic recovery, said Jim Swanson, chief investment strategist at the Boston-based asset management firm, during a conference call for the firm’s mid-year outlook Wednesday morning.
In the U.S., large-cap corporations are following well-established patterns for a strong recovery supported by capital expenditures (capex) and more hiring. As a group, large-caps have plenty of cash on their balance sheets—an 11% cash- to market-cap ratio, Swanson said. That is the highest amount of cash that the category has seen in a generation, and positions the group to do five important things. They could do mergers and acquisitions, stock buybacks, raise their dividend payouts, hire new workers or make more capital expenditures, he said.
The latter two options would give the economy a great boost, and there is already evidence that companies are doing those two things. Swanson says MFS has already seen capex pick up, and the stage is set for an increase, because as a percentage of depreciation, capex is running below historic norms, he said.
In terms of expanding the workforce, companies have been benefiting from productivity that started to increase during the recession, and unit labor costs that started to fall before the downturn. Historically, when U.S. companies have reached a new record in gross domestic product per worker, the labor force increases four months later. As if following a script, worker productivity hit a new high in November, and payroll numbers were up in March.
“In this country, profits as a share of gross domestic product (GDP) are continuing to rise,” Swanson said. “This is a recipe for this economic expansion to be sustainable.”
And consumers, an all-important cohort within the GDP, are not huddling in their homes, hoarding cash in fear of the worst, according to Swanson. Indeed, consumption in the U.S. fell 1.6% through 2008 and 2009, during the worse of the Great Recession. “I don’t know where this thesis comes from that the U.S. consumer is tapped out, overleveraged, and going to save more,” Swanson said. “There is very little evidence, historically, of this.”
MFS also has a brighter outlook on the outcome of the European sovereign debt crisis. And although European economic and have not completely solved the problem, they have a fallback: a banking system that has been immensely profitable in recent years and has built up enough reserves to absorb a worst-case fallout, Swanson said. If Spain, Portugal or Greece were to default on their debt, the event might trigger a 50% loss rate, and deplete 28% to 30% of the banks’ Basel II capital reserves. While that impact is significant, it wouldn’t completely wipe out the banks.
Also, European banks have leverage levels of 8x or 9x, which is far less than the 30x times leverage levels in the financial system preceding the Lehman Brothers failure in October 2008. Profits are on an upswing in European companies as well, Swanson said.