Two Things You Know About Companies That Aren't True

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Stocks' positive momentum continued today, as the Dow and the broader S&P 500 gained 0.6% and 0.8%, respectively. That drove the S&P 500 to another five-year high and, conversely, the VIX Index to a near five-and-a-half year low. Barring a single day during last August's doldrums, today's VIX closing price is the lowest since early June 2007 -- just prior to the beginning of the credit crisis. The VIX Index is a market measure of investors' expectations for stock market volatility over the next 30 days.

Two things you know about companies that aren't true
It's become a well-worn refrain in the financial and economic media that the balance sheets of U.S. companies have become bloated with cash as a result of the combination of the strong recovery in corporate profits, and a reticence to invest in a climate of continuing uncertainty. Not so, says Andrew Lapthorne, the head of quantitative equity research and one of the gadflys at French bank Societe Generale. According to Lapthome, when measured on a net debt to assets basis, companies are more heavily leveraged now than they were during the latter stage of the credit bubble (2005 through mid-2007).

Lapthorne's other contrarian finding is that the level of investment by U.S. businesses is consistent with previous capital spending cycles, i.e. companies have not been hoarding cash. While capital expenditures decelerated sharply, and eventually shrank, in 2008-2009, they have already been through a full recovery since then and are now decelerating once more.


What does this all mean for investors? If SocGen is right, the credit crisis has not broken or postponed the corporate investment and profitability cycles. That has sobering implications on both fronts: On the one hand, one should expect profit margins, which are at historic highs, to fall. On the other hand, the notion of an ocean of cash ready to super-charge the economy once corporate executives open the floodgates could be a yield-thirsty investor's mirage. Investors need to remain level-headed and opportunistic, particularly when complacency looks to be on the rise (see the comments on the VIX above.)

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The article Two Things You Know About Companies That Aren't True originally appeared on Fool.com.

Alex Dumortier, CFA has no position in any stocks mentioned; you can follow him @longrunreturns. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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