American Airlines went bust this morning, which should have come as a surprise to no one who has followed the company and airline industry over the years.
(The company recently denied bankruptcy rumours by stating that bankruptcy was “certainly not our goal or preference,” which is about as close as a corporation will ever come to saying “Of course we’re going to declare bankruptcy, you idiots, why are you even bothering to ask?”)
But the bankruptcy WILL come as a surprise to the millions of Americans who have repeatedly been exposed to one of the consensual hallucinations that bullish investors and pundits have been mouthing in recent months:
To wit: Corporate balance sheets are the strongest in history and companies are awash in cash.
It is true that companies have plenty of liquidity, which they didn’t a few years ago.
But corporate balance sheets are in fact no “stronger” than the balance sheet of someone who borrows a million dollars and then spends only little of it.
In other words, yes, corporations have lots of cash, but this is only because they have borrowed lots of cash. And as anyone who owes more money than they have will tell you, that’s not exactly the definition of “strength.”
These charts from fund manager John Hussman make this clear.
First, look at corporate cash as a percentage of debt and net worth. It’s up a bit from recent lows, but hardly the highest in history:
Photo: Hussman Funds
Then, look at total debt as a percentage of net worth. See? Companies still have debt coming out of their ears.
Photo: Hussman Funds
The best that can be said is that corporations are fairly liquid here, but this is a much different statement than saying that corporate balance sheets have “never been healthier in history.” In evaluating overall balance-sheet health, it is important to consider the overall debt burden of corporations.
As the following chart shows (based on Federal Reserve Flow of Funds data), the debt burden of U.S. corporations is near all-time highs, having retreated only modestly since 2009. Debt burdens are elevated regardless of whether they are measured against total assets or net worth. Certainly, corporations are presently benefiting from very low interest rates on corporate debt, which substantially reduces the servicing burden of these obligations. But the combination of high debt levels and low servicing burdens does create a potential risk to corporate health in the event that yields rise in future years. Overall, the picture is fairly stable at present thanks to low yields and high levels of cash-equivalents, but it is important for investors to keep in mind that cash can burn fairly quickly during economic downturns, and debt is not spread evenly across corporations.
The bottom line is that at an aggregate level, corporate balance sheets look reasonable, but are certainly not “stronger than they have ever been in history.” Cash levels are elevated, but this is at best a second-order factor (with excess cash representing only a few per cent of total assets), while debt remains near record levels relative to total assets and net worth. In any event, balance sheet risks should be evaluated on a business-by-business level, rather than accepting the blanket notion that cash levels are so high that nobody needs to worry about corporate credit risk.
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