Business Investments and Low Interest Rates

Business Investments and Low Interest Rates

 

Longstanding IS-LM macroeconomic framework says that low interest rates should result in higher investment (as the cost of capital for investments declines).  However, in practice it is not true.  Business Investment also depends on many other factors such as projections for economic growth, market growth,  and Industry/sector growth (in which a company operates).  Low Interest rates also indicate low economic growth environment.  In a low growth environment, having poor projections of future cash flows from new investments, companies can not justify domestic Investments if financial hurdle rates are not met.  

Corporations also may have attractive options for investment outside the country.  Free Trade agreements allow for business investments to move overseas for getting access to growing markets or for cost cutting reasons such as labor costs.

Instead of Investing in new capacity, companies are paying dividends, and buying back shares to boost share prices and doing acquisitions. Companies are using their own cash retained from earnings to pay dividends, buyback shares, and in some cases doing acquisitions. Debt-financed acquisitions are done through raising capital from capital markets.

Companies do not need to grow by new fixed investments when they can grow by acquiring other companies. Organic growth is the process of business expansion by increased output, customer base expansion, or new product development, as opposed to mergers and acquisitions, which is inorganic growth. Organic growth typically excludes the impact of foreign exchange.  

There has been spectacular M&A activity in 2014, 2015 and is continuing in 2016.  

In low economic growth and low interest rate environment, it may make more sense to grow by inorganic growth.  The justification for M&A is usually the combination of reduced costs of doing business and increased revenue from greater market share.   After completion of acquisition, acquiring company management may decide to rationalize business units – closing inefficient plants, laying off employees, combining overlapping internal corporate services departments.  These decisions depend on the type of M&A strategy.

Economists need to pay attention to these trends as well.  At present, there is no discussion of M&A activity in Economic Policy discourse among Economists and Policy makers.

 

Wall street data charts showing trends in Business Investments

na-cm077_resear_16u_20161026161806na-ck534_bizinv_16u_20160615183306

 

From  Jeff Cox / CNBC.com November 17 2016

Fed Chair Janet Yellen and her colleagues for quite some time have been bemoaning the low levels of business investment.

Pressed Thursday to explain why this has been the case, the central bank chief told Congress she wasn’t sure, but she denied it had anything to do with the Fed’s cheap-money policies of the past eight years.

“It’s not clear in my mind why it is that investment spending has been as weak as it is,” she told the Joint Economic Committee. “Initially, we had an economy with a lot of excess capacity. Firms were clearly operating without enough sales to justify a need to invest in additional capacity, and more recently with the economy moving toward full employment, we would expect to see investment spending pick up, and it’s not obvious exactly why it hasn’t picked up.”

Sen. Bill Cassidy, R-La., suggested that the fault may lie in what the Fed has done. Specifically, he pointed to the central bank’s quantitative easing measures that saw the Fed’s balance sheet surge to $4.5 trillion largely on three rounds of bond buying.

Faced with the uncertainty of returns from capital expenditures and the near-certainty of returns on assets like stocks and bonds during what Cassidy called “easy money” QE programs, businesses opted for the latter, he said.

“I wouldn’t agree that the Fed’s monetary policy has hampered business investment or been a negative factor,” Yellen responded. “I’m not aware of any evidence that suggests that it is.”

She explained that productivity has been on the decline since companies started reversing bare-bones employment levels during the financial crisis. However, that has not been met with business investment, in part because companies don’t believe it “will produce returns that justify those investments,” Yellen said.

 

From Moody.com

Moody’s: US non-financial corporates’ cash pile increases to $1.68 trillion, tech holding the lead

Global Credit Research – 20 May 2016

New York, May 20, 2016 — US non-financial companies rated by Moody’s held $1.68 trillion in cash at the end of 2015, up 1.8% from $1.65 trillion the year prior, Moody’s Investors Services says in a new report. The top 50 holders of cash account for $1.14 trillion of the total cash pile, and entry to the top 50 list now requires $6.12 billion in cash.

“The top four cash-heavy US industries remain technology, healthcare/pharmaceuticals, consumer products, and energy,” says Richard Lane, a Moody’s Senior Vice President. These four industries currently hold a record $1.3 trillion, or 77% of total corporate cash and have accounted for more than 72% of the total every year since 2007.

The top five cash holders are Apple, Microsoft, Google, Cisco Systems and Oracle, Moody’s says in “US Non-Financial Companies: Cash Pile Grows 1.8% to $1.68 Trillion; Tech Extends Lead Over Other Sectors.”

Apple held $215.7 billion in total cash for the period. The company has held the top spot as cash king since 2009.

“While the concentration of cash among the top-rated cash holders continues to grow, so too has the portion held by the technology sector, which accounted for a record 46% of total cash in 2015, up from 41% in 2014,” Lane says.

Moody’s expects the technology sector cash concentration will grind higher over the next year because of the sector’s strong cash flow generation and despite stronger returns of capital to shareholders. The technology sector generated 63% of the total rated non-financial free cash flow in 2015, up from 37% in 2007.

For the top 50, capital spending fell by 3% to $885 billion, and net share buybacks fell 7% to $269 billion. Dividends increased by 4% to a record high of $404 billion, while acquisition spending increased 43%, to a record $401 billion.

For the first time since 2012, cash coverage of aggregate debt maturities over the next five years fell below 100% to 93% at the end of 2015.

In 2016, Moody’s expects aggregate spending on capital investments, dividends, acquisitions and share buybacks to again approximate $1.9 trillion.

 

From Wall Street Journal

mi-cp973_divide_16u_20160603184210

 

From DealLogic

mw-dn118_ma_acq_20150602090958_mg

 

From M&A experts weigh in on deals for 2017

manda3manda2017

 

From  US M&A market on a high

us-ma-2015

From IMAA

usmabestusmabest2

 

Key ideas/issues for M & A:  

Why grow through M & A activities ?

  • Limited organic growth options
  • Need to address the transformation in the marketplace/existing business models
  • Availability of credit on favorable terms
  • Large Cash reserves/commitments
  • Shifting consumer demands
  • Improving Equity markets
  • Opportunities in emerging markets

What are concerns?

  • Slow growth environment
  • Lack of suitable targets
  • Record stock prices
  • Geopolitical risks
  • Others
  • Constrained Consumer Demand
  • Regulatory Considerations
  • Rising Interest Rates

 

 

Key terms:

  • Return on Investment (ROI)
  • Return on Invested Capital ( ROIC)
  • Internal Rate of Return (IRR)
  • Weighted Average Cost of Capital (WACC)
  • Economic Value added (EVA)
  • Return on Assets (ROA)
  • Return on Equity (ROE)
  • Net Present Value (NPV)
  • Compound Annual Growth Rate (CAGR)
  • Capital Expenditures ( CAPEX)
  • Corporate Savings Glut
  • Business Fixed Investments
  • Share Buybacks
  • DIvidends
  • Acquisitions
  • NAFTA
  • TPP
  • TTIP
  • International Investment Position (IIP)
  • Free Trade
  • Direct Investment Position (FDI)
  • Trade Flows
  • Current Account
  • Capital Account
  • Organic Growth
  • Inorganic Growth

 

 

Key Sources of Research:

 

Business Investment in the United States: Facts, Explanations, Puzzles, and Policies

Remarks by Jason Furman Chairman, Council of Economic Advisers

September 30, 2015

 

https://obamawhitehouse.archives.gov/sites/default/files/page/files/20150930_business_investment_in_the_united_states.pdf

http://www.progressivepolicy.org/wp-content/uploads/2015/09/2015.09.30-Jason-Furman_Business-Investment-in-US-Facts-Explanations-Puzzles-Policies.pdf

 

 

Firms’ Investment Decisions and Interest Rates

Kevin Lane and Tom Rosewall

http://www.rba.gov.au/publications/bulletin/2015/jun/pdf/bu-0615-1.pdf

 

 

Investing when interest rates are low

By Timothy M. Koller, Jiri Maly, and Robert N. Palter

http://www.mckinsey.com/business-functions/strategy-and-corporate-finance/our-insights/investing-when-interest-rates-are-low

 

 

Are low-interest rates contributing to low business investment?

By Nick Bunker

http://equitablegrowth.org/equitablog/are-low-interest-rates-contributing-to-low-business-investment/

 

 

Why isn’t Investment More Sensitive to Interest Rates: Evidence from Surveys

Steve A. Sharpe and Gustavo A. Suarez

2014

https://www.federalreserve.gov/econresdata/feds/2014/files/201402r.pdf

 

 

Why Aren’t Low Rates Working? Blame Dividends

Since the Federal Reserve took rates to near zero, companies have boosted buybacks 194%

http://www.wsj.com/articles/why-arent-low-rates-working-blame-dividends-1465119005

 

 

Low Interest Rates Are Hurting Growth

http://www.forbes.com/sites/realspin/2016/10/04/low-interest-rates-are-hurting-growth/#5e9ccf813a2b

 

 

Secular Stagnation and Returns on Capital

Paul Gomme,  B. Ravikumar, Peter Rupert,

https://files.stlouisfed.org/research/publications/es/15/ES_19_2015-08-18.pdf

 

 

The Return to Capital and the Business Cycle

Gomme, Paul, B. Ravikumar, and Peter C. Rupert, 2006.

Federal Reserve Bank of Cleveland, Working Paper no. 06-03.

https://www.clevelandfed.org/en/newsroom-and-events/publications/working-papers/working-papers-archives/2006-working-papers/wp-0603-the-return-to-capital-and-the-business-cycle.aspx

 

 

Long-term investment, the cost of capital and the dividend and buyback puzzle

Adrian Blundell-Wignall and Caroline Roulet

https://www.oecd.org/finance/Long-term-investment_CapitalCost-dividend-buyback.pdf

 

 

The “Search for Yield” and Business Investment

By Jason M. Thomas

https://www.carlyle.com/sites/default/files/market-commentary/productivity_slowdown_may2016_final.pdf

 

 

Infrastructure versus other investments in the global economy and stagnation hypotheses: What do company data tell us?

Adrian Blundell-Wignall and Caroline Roulet*

https://www.oecd.org/investment/Infrastructure-versus-other-investments-Global-economy-Stagnation-hypotheses.pdf

 

 

(Why) Is investment weak?

Ryan Banerjee Jonathan Kearns Marco Lombardi

http://www.bis.org/publ/qtrpdf/r_qt1503g.pdf

 

 

The Fed Has Hurt Business Investment

by Michael Spence, Kevin Warsh

http://www.hoover.org/research/fed-has-hurt-business-investment

 

 

FRED data series on Savings and Investments

https://fred.stlouisfed.org/categories/112

 

 

Weak Business Investment, Lower Neutral Rate Impacting Each Other

http://www.theepochtimes.com/n3/2160321-weak-business-investment-lower-neutral-rate-impacting-each-other/

 

 

The Corporate Saving Glut in the Aftermath of the Global Financial Crisis

Joseph W. Gruber and Steven B. Kamin

https://www.federalreserve.gov/econresdata/ifdp/2015/files/ifdp1150.pdf

 

 

Rising Intangible Capital, Shrinking Debt Capacity, and the US Corporate Savings Glut

Antonio Falato Dalida Kadyrzhanova Jae W. Sim

November 2012. This version: June 2013

http://www.cepr.org/sites/default/files/events/papers/5599_KADYRZHANOVA_Cover%20-%20Rising%20Intangible%20Capital,%20Shrinking%20Debt%20Capacity%20and%20the%20US%20Corporate%20Savings%20Glut.pdf

 

 

Corporate Profits and Business Fixed Investment: Why are Firms So Cautious about Investment?

Naoya Kato and Takuji Kawamoto

April 2016

https://www.boj.or.jp/en/research/wps_rev/rev_2016/data/rev16e02.pdf

 

 

The Evolution of Corporate Cash

John R. Graham
Mark T. Leary

Draft: February 2015

http://www.rhsmith.umd.edu/files/Documents/Departments/Finance/seminarspring2015/graham.pdf

 

 

Adverse Effects of Ultra-Loose Monetary Policies on Investment, Growth and Income Distribution

Andreas Hoffmann & Gunther Schnabl

http://www.savings-banks.com/SiteCollectionDocuments/Savings%20and%20Investment%20During%20the%20Great%20Depression%20and%20the%20Recent%20Global%20Crisis.pdf

 

 

NAFTA at 20

AFL-CIO

http://www.aflcio.org/content/download/121921/3393031/March2014_NAFTA20_nb.pdf

 

 

The North American Free Trade Agreement (NAFTA)

 

M. Angeles Villarreal

Ian F. Fergusson

April 16, 2015

https://fas.org/sgp/crs/row/R42965.pdf

 

 

 

NAFTA Revisited

PIIE

http://big.assets.huffingtonpost.com/NAFTA_Revisited_Text.pdf

 

Direct Investment Positions for 2015 Country and Industry Detail

 

By Derrick T. Jenniges and James J. Fetzer

July 2016

 

http://www.bea.gov/scb/pdf/2016/07%20July/0716_direct_investment_positions.pdf

 

 

Activities of U.S. Multinational Enterprises in the United States and Abroad

Preliminary Results From the 2014 Benchmark Survey

 

http://www.bea.gov/scb/pdf/2016/12%20December/1216_activities_of_us_multinational_enterprises.pdf

 

 

2015: A Merger Bonanza
Nearly $5 trillion worth of deals were announced last year. Why do so many big companies want team up?

http://www.theatlantic.com/business/archive/2016/01/2015-mergers-acquisitions/423096/

 

 

M&A experts weigh in on deals for 2017

https://info.kpmg.us/ma-survey-2017.html?gclid=Cj0KEQiAkO7CBRDeqJ_ahuiPrtEBEiQAbYupJaJUqUI61s1m-kFVDnT112-3ocH1SdVfcCxiBiNX614aAuvj8P8HAQ

 

 

 

The Federal Reserve’s Impact on the US M&A Market: An Empirical Examination

Sebastian v. Boetticher

Spring 2015

 

http://www.cob.calpoly.edu/undergrad/files/2015/09/Boetticher.pdf

 

 

M&A Statistics

IMAA offers extensive and up-to-date information, data, research on M&A and Mergers & Acquisitions statistics

https://imaa-institute.org/mergers-and-acquisitions-statistics/

 

 

Hearing: The Economic Outlook

Janet Yellen on November 16 2016 speaking at Joint Economic Committee

Listen/view at 1:33:00 her comments on Business Investments

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Author: Mayank Chaturvedi

You can contact me using this email mchatur at the rate of AOL.COM. My professional profile is on Linkedin.com.

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