As geopolitical turmoil roiled the stock market last week, it was easy to forget something so crucial to remember as earnings seasons heats up: Corporate America hasn't looked so financially secure since the 1960s.

Credit markets, ratings actions and cash balance sheets tell us that companies are unlikely to close their wallets, hinting at the potential for a recovery by the beleaguered stock market.

Stability in the credit markets last week stood in stark contrast to the (near) panic in the stock market, which sent the Nasdaq Composite down 4.4% for the week to its lowest level since October. The Dow fell 3.2% last week, while the S&P 500 shed 2.3%.

Conversely, spreads on high-yield bonds averaged 333 basis points over comparable Treasuries Friday, tighter (or better) by 18 basis points from the start of the year, and still not far off their historic tight levels of 270 reached in 1997. Junk bonds are a virtual Zen Buddhist monastery compared with the recent bleeding in the stock market.

"The high-yield market never went along for that ride equity market volatility with the same ferocity," says Christopher Garman, chief high-yield strategist at Merrill Lynch. "The bottom line is that the credit markets are less prone to bouts of enthusiastic optimism or pessimism, and instead just look at the likelihood of getting debt repaid."

Indeed, bond investors essentially focus on companies' financials and ability to repay debt. Meanwhile, stock investors focus on earnings growth and forecasts, which can cloud the true picture of corporate strength -- especially when geopolitical strife is sending oil prices to record highs. Relatively tight spreads, or risk premiums, for even high-yield bonds -- which typically track the equity market more closely than high-grade corporates -- reveal a sense of security in companies' financial health.

When corporate giants like Citigroup ( C), Pfizer ( PFE) and Microsoft ( MSFT) report earnings this week, remember that companies have just scratched the surface when it comes to capital expenditures.

And when Caterpillar ( CAT), Schlumberger ( SLB), and Halliburton ( HAL) report, remember that high oil prices may take their toll on profits, but American companies have a historically massive cash cushion to absorb the high costs of materials.

Non-financial corporations had $1.324 trillion of cash on their balance sheets as of the end of the first quarter, according to Moody's. Corporate America's ratio of cash to total debt outstanding stood at 24.3%, which is off slightly from a peak at 25.2% in the fourth quarter of 2005, but still one of the highest measures since 1967.

In the best years of the last economic cycle, debt weighed much heavier on company balance sheets. The ratio of cash to total corporate debt was only 18% in the first quarter of 1996, according to Moody's.

All that cash means companies have a lot of spending power and more than enough in their pockets to justify doling out some shareholder dividends or buying back stock.

Non-financial companies spent $983.97 billion in the first quarter of 2006, according to the Commerce Department. Cash on hand is running at 135% of spending, down from 143% in the fourth quarter of 2006, but at the strongest levels since the early 1960s. In the first quarter of 1996, that ratio was only 90%.

"They aren't going to just put that cash in a checking account while their stocks go down," observes contributor James Altucher, who expects more M&A activity, more stock buybacks, higher dividends and investment in R&D and infrastructure.

"All of those items boost stock prices and boost the economy," writes Altucher, a managing partner at Formula Capital, an alternative-asset management firm. "We haven't even really seen the effects yet of the massive cash that's sitting on the sidelines right now in corporate America. "

Indeed, with massive cash on their balance sheets, fears of shrinking GDP should be tempered by some faith that corporations can take up the slack if consumers fall off the map.

Borrow This

Just like so many homeowners, companies took advantage of historically low interest rates earlier this decade to refinance their debts -- swapping higher interest rates and near-term maturities for low, longer-dated debts. Companies also took advantage of the low rates to lock in cash and credit facilities they expected to tap down the road (as in now). But companies became conservative about spending and hoarded much of their borrowings, as hard-learned lessons of overspending in the telecom and tech build-out of the late 1990s remained fresh.

Corporations have increasingly opened their wallets in recent years, thanks to the dividend tax cuts and pressure from activist shareholders.

In the first half of 2006, corporate America bought back about $200 billion in stock and paid out $108 billion in dividends, The Wall Street Journal reported last week in an inflammatory story entitled "Corporate Debt Begins to Worry Bond Investors."

Bondholders will always gripe when companies do shareholder-friendly activities. But the notion that the increase in stock buybacks and/or dividends threatens creditworthiness is premature. Thus far, there have been only 32 shareholder payment-related credit ratings downgrades this year, compared with the total 216 credit rating downgrades, according to Moody's.

Even if bondholder complaints are misplaced (or misreported), buybacks have yet to prove much of a boost to stock performance, writes Henry McVey, chief U.S. investment strategist at Morgan Stanley. Many companies doing buybacks are companies without much to invest in growth-wise, he writes, noting buybacks are less successful than they seem when you account for hedging and fees.

"Capital management in isolation is rarely a strategy for significant stock-price success," writes McVey. "Improving business fundamentals must also be in evidence."

Fundamentals are not crumbling, however, and any credit crunch is far off. Banks are still open for lending and access to capital in the public debt markets is strong. Easy lending standards, buoyed by a derivatives market that helps banks lay off risk, may not be healthy in the long run. But it is certainly extending the credit cycle well into the economic cycle.

Default rates are low at 1.7%, and ratings actions show credit quality is not deteriorating regardless of expectations for an economic slowdown. The ratio of upgrades to downgrades in the second quarter improved, as did the number of "positive outlooks," and the number of ratings under review for an upgrade, according to Moody's.

Merrill Lynch's distress ratio currently measures 2.8%. The distress ratio measures the number of bonds in the high-yield universe that trade with spreads over 1000 basis points to comparable Treasury bonds. Many bond investors use the ratio as a predictor of Moody's global default rate eight months down the road; the current reading forecasts a 2.4% global default rate by February 2007.

So as earnings filter in, the bond market seems to be saying the dark mood in the stock market is overshadowing some fundamental strength.
In keeping with TSC's editorial policy, Rappaport doesn't own or short individual stocks. She also doesn't invest in hedge funds or other private investment partnerships. She appreciates your feedback. Click here to send her an email.

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