US Companies Are Playing a Dangerous Game: SocGen’s Albert Edwards
Data pointing to promising levels of bank lending and money supply in the United States, which have been touted as signs of a recovery, should be treated with caution according to Albert Edwards, strategist at Societe Generale.
The corporate sector is simply borrowing to buy back their own equities, says Edwards, a tactic that usually ends badly if history is to be believed.
"The recent surge in the money data should be seen as a sign of the ills in the U.S. economy, not health," Edwards said in a research note.
"We think corporates borrowing by the bucketful to buy in their own equity will end badly, it always does!"
Seasonally adjusted figures from the Federal Reserve show that M2, a measure of money supply, grew steadily in 2012. From July till the end of October it had increased by 8.6 percent and figures for bank lending showed similar gains.
Edwards, a vocal equity bear, warns that this promising data doesn't spell the end of private sector deleveraging and the start of a self-sustaining economic recovery.
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"The rebound in U.S. monetary data encapsulates everything that is wrong with a zaitech-crazed U.S. corporate sector," he said, suggesting that it's the corporate sector that ends up as the only major buyer of shares near the peak of the market in order to improve their earnings per share numbers and then they quickly switch back to issuing shares as the market crashes.
Delving into the Fed's monthly data, Edwards sees a cash-rich corporate sector that is favoring the bond markets as yields are being suppressed by Ben Bernanke's quantitative easing. These firms then use this debt to buy back their own equities.
(Read More: Bernanke's 'Ruinous' QE Will Lead to Rapid Inflation: SocGen's Albert Edwards)
"So to that extent, Helicopter Ben's approach of printing money to drive asset prices up actually seems to be working," he said. "Newly printed money is clearly finding its way into the hands of willing corporate buyers of equity via the banking sector."
Companies are choosing this method to boost their earnings per share, according to his Societe Generale colleague Andrew Lapthorne.
"It's called gearing or balance sheet risk and will come to haunt some firms when the economy enters a downswing," he said, adding that both U.S. and European firms are engaging in the practice.
Edwards contrasts it to the credit crunch in the early nineties when banks piled into U.S. Treasurys to play the steep yield curve, which he recalls ended badly.
He warns that when the next leg in the structural bear market occurs a steep downturn in bank borrowing and monetary aggregates will follow.