US corporations still in recovery mode

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The Federal Reserve flow of funds table, L.102 Nonfarm Nonfinancial Corporate Business, provides a general view of the financial situation of US corporations as of Q4 2009.

The rubble of 2008 has not yet been cleaned away.

The L.102 table is not a complete balance sheet of US corporations, but only reports on certain financial assets and liabilities. For example, it is not possible to deduce liquidity in terms of current ratios from this table.

The general question that I would like to address is simply this: To what degree have US corporations been able to improve their financial liquidity since the Crash of 2008?

The Fed flow of funds accounts provide a general, although highly imprecise answer to this question.

Financial assets to market liabiliies

The first ratio to examine, provided by data in flow of funds table L.102, is the percentage that total corporate financial assets make up of total credit market liabilities of nonfarm, nonfinancial business corporations.

The red line on this graph shows this ratio over the years 2005 to 2009, taking in the period before and after the Crash of 2008.

Selected Ratios: Fed FOF Table L.102 Nonfarm nonfinancial corporate business

Although this ratio is in no way comparable to standard ratios used in financial analysis of individual companies, it does provide a general view of the relationship between the liquid assets of corporations to the total long and short-term market debt of these companies.

What this ratio shows is that the liquidity of US corporations had been trending downwards for several years before the Crash of 2008, and that the subsequent recovery, although fast, has still not reached the liquidity levels of 2005.

What this ratio does not explain is whether liquidity levels of 2005 were adequate or not — although the Crash of 2008 would seem to suggest that the answer would be no.

Whereas behavior of US households (See: US households save while Obama fiddles) indicates a strong shift to more conservative financial positions — with far higher levels of saving than prior to 2008 — corporations do not seem to have seen the same light on the road to Damascus.

In fact, corporate executives are already anxious to get back to their stock buyback-option schemes and resume their piggish remuneration programs.  (See: Soviet style capitalism on Wall Street).

Liquid assets to market capitalization

Benjamin Graham, Warren Buffett’s guru, liked to compare net working capital per share to market price as an indicator of whether a stock was truly cheap.

Despite Obama's bad mouthing the economy for political gain, Americans are still a long ways from the Great Depression

This was during the years of the Great Depression.

Although it has been generations since this indicator has had much practical use, it is still interesting to know how much of market capitalization of US nonfarm nonfinancial corporations is represented by liquid assets (not the same as net working capital).

The blue line in the above graph shows that leading up to the Crash of 2008, the ratio of corporate financial assets to market capitalization was declining — a possible indicator of over-pricing.  A drastic reduction in market values, as a result of the Crash, sent this ratio upwards.

The bear market recovery of 2009, has moved this ratio downwards again, but still well above pre-Crash levels.

Again, as in the case of the first ratio shown by the red line, no conclusions as to whether equities are properly priced can be deduced from this ratio.

Corporations are still vulnerable

American business is still running in full asset-lite mode, with heavy reliance on debt and a reluctance to build strong balance sheets or reserves for possible future hard times.

With the Obama administration eagerly engaged in tearing down the economy, piling up an unsustainable debt burden and counting on ever higher taxes to stave off inflation, the possibility of a double dip recession, or worse, does not seem at all far-fetched.

Nevertheless, stock prices continue to rise. We are reminded of the bear market rally of 1929-1932.

It would seem that caution would be the better part of valor in this market.

What do you think?