Business Cycle or Credit Cycle?

[On the Road]

Cycle Paths…As we’ve mentioned a few times in the past, we believe there is one question that is the key to understanding and successfully navigating the current economic and financial market environment. Point blank, and although this may sound wildly melodramatic and over the top, we believe that the correct answer to this question will absolutely determine success or failure for investors looking ahead. We’re just trying to keep it simple and distill all of the noise and daily sound bites blaring at us from the financial media down to one overriding issue. Here goes. Is the current post recessionary economy more properly characterized as a business cycle or a credit cycle? Which one is it? Answer the question correctly you win the prize. And we’re not kidding.

What stands out to us like a sore thumb in the current recovery cycle is the dichotomy of character relative to past economic recovery periods. In so many key economic indicators of the moment, we see activity almost completely opposite of historical experience during recovery cycles. Is it the new "service economy" that appears to be reshaping the rules? Is it the rapid globalization of economic activity that is being displayed in such a dramatic change of domestic economic character? Or is it simply the fact that what we are living through is not a business cycle at all, but rather a credit cycle?

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Switching gears for just one second, we want to have a very quick look at the current character of corporate spending. You remember, the “business” part of the economic recovery cycle, so to speak. What you see below is the history of net corporate cash flow as a percentage of GDP on top of the coincident time period chart detailing non-residential fixed investment as a percentage of GDP (a proxy for corporate capital spending). It’s pretty darn clear that as corporate cash flow grew in the 1970’s, corporate capital spending mushroomed. At the time, much of this went into energy infrastructure. Same deal in the post recessionary period of the 1990’s. Corporate cash flow grew big and so did capital spending centered primarily in tech equipment. In other words, as corporate cash flow has accelerated over time, so has corporate capital spending. The patterns are pretty darn clear.

So here we have current net corporate cash flow as a percentage of GDP near all time highs. The current cycle has no precedent in terms of strength. Yet coincident time period capital spending relative to GDP has modestly increased relative to this burst of cash flow. Just what’s going on here? Why aren’t corporations spending their cash more aggressively? After all, they are literally spitting out cash at the moment. This too is an anomaly right alongside the consumption and employment pattern dichotomies described above.

http://www.contraryinvestor.com/mo.htm



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Note: Just discovered this site, and it seems like a pretty good mix of sophistication and clarity. The author's position is takes longer than four paragraphs to lay out, so the snipped portion doesn't do the argument justice.