Expert Commentary

Deflation: Investors Give Cash Away

More evidence that deflation is only just starting.

In deflation, cash is king because it increases in value as all other assets are falling. However, at the start of a deflationary environment most investors are ignorant of what is going on and expect the old trends to re-assert. Incredibly, as the global economy implodes, there is evidence coming through that investors are still falling over themselves to lend their cash out to private sector corporate entities.

According to Dealogic, corporate bond issuance by "investment grade" companies surged to over $244 billion in March. That's the highest monthly total since a record $252 billion was borrowed from investors in September. Issuance spiked up after the Federal Reserve announced it would start buying corporate bonds. "Buy what the Fed is buying," said at least one talking head on financial television I heard.

The problem is that psychology is changing. Fast. In September, when the last investment grade bond issuance splurge occurred, corporates were in a different place. They were borrowing for LBOs or buybacks, the crazy top-of-the-market sentiment that EWI has been warning about for months. Now, though, corporates could be issuing debt in order to suck in cash to provide a buffer zone. Perhaps the reality that cash is king is dawning on corporates.

For investors, however, they see investment grade yield spreads blowing out as an opportunity to pick up bargains. They look at the recent history of the yield spread and think that it's a wonderful time to pick up some extra, high-quality yield. Yet as the chart below shows, investment grade spreads are still far below the level reached in 2008. The mental blockage in these investors' minds is the growing risk of downgrade and default by current highly rated corporates. For sure, high-quality corporates with large cash piles will be in a better position than most to ride out the deflation storm but that's cash with no claim on it. If corporates are trying to bolster their cash position by issuing debt, it's actually a sign of how bad things are already.

According to an investment banker quoted in the Financial Times, corporates are borrowing money because, "People want to build a cushion for economic uncertainty," adding that "when you get the opportunity to access the market, people will jump through that window."

By the end of this debt-deflation, unfortunately, jumping out of windows might be all-too common.

200403 - MG