Traditionally, business investment used to rise when US companies took on more debt and companies took on more debt when the interest rates were cut, making it cheaper to borrow money and deliver a boost to the economy. That was the prevailing theory until the one link in the machinery recently broke down.
Companies are not using the debt toward investments but instead to buy back shares to boost their EPS (Earnings Per Share) and consequently the valuation of their stock and most importantly, the share price. Alternatively, the money is used to pay out dividends which also makes the company’s stock look more attractive. Why the shift in strategy? Because more and more CEOs are incentivized with driving share prices higher rather than growing revenues through investment. Corporate debt has climbed to record levels and time endured tradition of using that money to invest in future growth or acquisitions to drive synergies seems to have been lost in the pursuit of adding personal executive wealth.
Future Wealth’s View
When asked the question if lower interest rates will indeed spur economic growth, Fed Chair Powell gave a convoluted answer recognizing that much of the money is not going to be invested into the economy directly but through higher asset prices that could improve confidence levels in consumers who, in turn, will spend more, thereby driving economic growth.
Now, what if the capital does not end up being spent back into the economy and instead ends up in a savings account somewhere? Americans are so badly saddled with debt that higher consumer confidence may not drive spending but, instead, could be channeled toward paying off loans. That is money that has already been spent (so to speak), kinda like credit card payments for things that we bought last month or last year. Consequently, the noble notion of an interest rate cut could ultimately have little impact if corporate debt is not reinvested and any additional monies at the consumer level goes toward paying off loans.
In summary, some of the macro trends like corporate debt and interest rate cuts have begun to show different movements in different directions than previously modeled by the Fed and most economists. For the average investor, these are signals that the landscape is shifting and the old ways of saving and investing may no longer work. It is time to pay attention.