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Balancing Record-breaking Cash Injections with Debt

During 2020, “Cash hoards swelled … after companies issued record-breaking amounts of debt to bolster their balance sheets against the Covid-19 pandemic’s disruptions … US companies had sold more than $2 trillion of investment-grade and high-yield bonds … At the same time, many cut share repurchases, dividends or capital expenditures.” – The Wall Street Journal

We saw a reversal of this situation later in 2020, raising hopes for moves such as buybacks, driving share prices higher, and paying down debt, reducing risk for bondholders. Wall Street analysts expected companies to start dipping into more of their cash in 2021, and then a resurgence of the COVID virus hit. Nearing the end of 2021, we are still bloated with liquidity, but it is soon to end. The seemingly endless supply of money dumped into the economy by central banks, private lenders, and governments has finally peaked.

How Do We Maintain Investment Assets Going Forward?

In many ways, the most misunderstood concept today is liquidity. Did all that extra cash provide liquidity? Maybe, but it is also a dynamic term when maintaining investments as all other values are constantly changing and affecting the percentage of your organization’s entire financial portfolio. Although not readily discussed, asset growth in many different classes appreciates, and portfolios are frequently “re-balanced.” Given the significant appreciation in equities, money will move towards alternative hedge funds, private equity, real estate, and other less liquid strategies.  

Don’t all markets move this way? Although this may be true, the typical market movement has been altered by the massive amount of stimulus injected into the financial system due to a COVID economy. Liquidity may be an important issue if assets reach a more correlated return and appreciation suitable for slower growth.

As asset prices appreciate to higher highs, it may warrant viewing cash as a core holding and perhaps a higher allocation, as we consider future liquidity and increasing structured products.

Preparing to Walk Again

As the world’s central banks ease off the stimulus lever, it will force economies and financial markets to practice different strategies to continue to grow the company portfolio. Many have profited by more liquidity, but not everyone is disappointed to see the stimulus end and return to a more familiar economy and financial market. Adding roughly $27 trillion to the global gross domestic product caused some wild unpredictability, and we are ready to adjust to a sense of normalcy over the next few months.

Reuters reports world stocks have surged 85%, and economic growth and a rebound will balance out the devastation from 2020. Inflation and interest rates will rise once again. If the stimulus continued at last year’s pace, it could do more harm than good. The cash injection has been falling relative to GDP since January, and excess liquidity is contracting. Economies are recovering strongly, and bond markets are finally pricing in the return of inflation.

That doesn’t mean liquidity or cash won’t remain plentiful. Central banks still maintain loosened monetary policies. And liquidity isn’t always about cash. The cash holdings of global investors relative to the size of their equity and bond holdings are now on the low side, so we must rely on other assets to maintain our growth trajectory. It may be time to taper spending to avoid a drastic tightening that could derail your company goals.

Economic growth, along with revenue growth, will transform slowly while inflationary pressures and interest rates rise. Many companies may expect to choose between paying off debt rather than investing. Prepare your investment portfolio knowing that cash reserves may not flow into US equities quite as they should.

Positioning Portfolios in 2021

For more than a year, the incredible gap between financial markets and the economy has continued to widen. A rapid recovery in asset prices in March took major US indices to record levels, and a mass amount of debt was issued at historically low levels of return for creditors. Looking back helps us to discover a new position for the future.

The global economic situation may remain uncertain as another coronavirus wave has parts of Europe experiencing another recession. Clearbrook sees that as a great reason to invest in the US to promote domestic recovery and reposition for long-term growth.

Some companies have already begun investing in protective asset classes only indirectly supported by central bank funding. Others responded by front-loading their buying but also finding related opportunities for funds with higher rates of return. The real economy has detached from the markets, and investors need to be wary. Move away from the seemingly endless liquidity-driven conventions and back to the fundamentals as we move closer to the end of 2021.

While attempting to offset the impact of corporate bankruptcies, some investment strategies ventured into unfamiliar asset classes that lack sufficient liquidity for correction. It’s not too late to reestablish financial goals and get the portfolio back on track.

At Clearbrook, we navigate an uncertain landscape with analytical tools, using granular credit and technical evaluations, credit structuring, scenario planning, carefully calculating the liquidity in various market segments to better understand how to recover from last year’s investment mistakes. We help to re-examine or rethink the balance between equity funds and fixed income. Going back to fundamentals can validate increased asset prices and begin rebalancing the fallout from excess liquidity, investing in structured products with returns to offset debt.

Reframe your concept liquidity. Remember that investment values constantly change your organization’s financial portfolio, shifting asset growth in many different ways. It’s time to rebalance equity by determining how much cash to reserve and consider less liquid alternative investment strategies.  

Sources:

Roberts, L., MarketWatch, 2021. Opinion: Investors are waiting for ‘cash on the sidelines’ to juice the stock market — this is why that idea is hogwash, https://www.marketwatch.com/story/investors-are-waiting-for-cash-on-the-sidelines-to-juice-the-stock-market-this-is-why-that-idea-is-hogwash-11609795905

El-Erian, M., Financial Times. The risks that investors should prepare for in 2021. After a liquidity-driven rally on markets, central bank largesse might not be sustainable. https://www.ft.com/content/3cf4755f-3514-4131-a814-0fa4a387ca6a

Carvalho, R. and Wilkes, T., Reuters, Analysis: Global liquidity is shrinking and that’s no bad thing, https://www.reuters.com/business/global-markets-cenbank-analysis-2021-05-20/ 

Davies, P.J. and Pellejero, S., Wall Street Journal, 2020. Investors Circle Largest Corporate Cash Hoard Ever, https://www.wsj.com/articles/investors-circle-largest-corporate-cash-hoard-ever-11607086917 

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