Cash Rich, Balance Sheet Poor

Interesting weekly comment by John Hussman, particularly the back half devoted to corporate balance sheets. Many bulls claim that corporations are 'flush with cash' and that corporate balance sheets 'have never been stronger.' As Dr J demonstrates, these claims have little merit.

When compared to the amount of debt on corporate balance sheets, cash has been coming off historical lows. Cash as a fraction of net worth and total assets is also small (in the 5-10% range).

As such, much of the 'cash' on corporate balance sheets comes from debt. Corporations have been building cash in this manner due to cheap financing terms.

Make no mistake, the dominant feature of today's corporation continues to be debt and leverage, not cash.

John also comments on another eye-opening trend: the decline in tangible assets in non-finance corporations. The fraction of tangible assets to total assets is now below half. The remaining assets are financial assets such as debt securities and stocks.

As John notes, "This is striking, in that we presently have a menu of prospective returns on financial assets that is among the most dismal in history."

This is another argument for tangible assets (e.g., commodities) over financial assets, and for companies that are weighted toward more tangible assets.

position in commodities

High Hedge Fund Cash Levels

Bloomberg reports that many large hedge funds have low net risk levels and high cash positions. For example, George Soros' Quantum Fund is carrying about 75% cash.

Many large hedgies are 'macro' funds, meaning that they allocate assets and trade on broad macroeconomic theses. Fund managers state that they have lowered risk levels because the macro picture is murky. On the one hand, growing debt problems around the world make for a bearish macro scenario. On the other hand, governments seem poised with vast interventionary resources, which may be bullish.

Keep in mind that the 'clarity' that hedgies currently seek may arrive at pretty much the same time for all. Expect some big moves if/when.

position in SPX

US Money Market Exposure in Europe

Learned via Bill Fleckenstein today that Jim Grant, in his most recent newsletter, has observed that US money market funds have substantial fractions of their assets invested in European bank debt. Many money fund managers have been extending themselves abroad in search of yield, given the Fed's suppression of short rates to essentially zero.

The five largest domestic money market funds (three at Fidelity, one at Vanguard, one at Blackrock) with about $400 billion under management have about 45% of their assets in Euro bank paper.

If a credit crisis commences in Europe on the back of sovereign debt probs, then the spectre is raised that collapsing Euro bank paper could pressure net asset values of US money market funds to the point where they could 'break the buck' (fall below the $1 unit value). This occured to a small degree two years ago here in the US.

The implication is that US investors should make sure that they understand the nature of their cash holdings. Some funds may be FDIC insured. Current insurance amount, which was raised during the recent credit crisis, is $250,000 per depositor per insured bank.

For cash holdings that exceed the insurance limit or that are not covered, then the strategy should be locating the safest principal preserving vehicle possible. For those who are capable, this might mean parking cash in 1 to 3 month T-bills. They yield next to nothing but likely reflect the surest bet on preservation of principal.

Some believe that the US government would intervene should US money market funds begin to feel stress. Based on history, that may be a good bet. It is also one of the reasons why moral hazard is so high among bank depositors. As a class, depositors are largely clueless of the issues discussed here since they figure that the government has their back.

Nasty Head Fake

Yesterday's nice move higher appears to have been a nasty head fake, as domestic equity markets were weak out of the gate today. They steadily ground lower and finished on the lows. The Dow was down about 280, which is the largest single day point drop in some time.

Am starting to wonder whether the major indexes might not have a date with their respective uptrend lines stretching from the Spring 2009 lows.

For the S&P, that would correspond to about SPX 1250 which is also where the 200 day moving average currently resides.

What in the fundamental or macro environment might drive weakness from here? There are many possibilities, cookie. But given how heavy the banks are trading (the BKX was down over 4% today), it 'feels' like markets may be worried about contagion from the ongoing Greece/Spain/etc EU saga.

Over the past couple of weeks, I've been selling strength to get more liquid. Cash level is now at 60%. Wouldn't mind more, as the market action is increasingly taking on a deflationary feel.

position in SH