Will Companies Invest Their Christmas Cash Back in the U.S. Economy?

Tomorrow’s Christmas Eve… In my family, we used to celebrate at my grandmother’s house back in Maryland, and then have Christmas Day at my mother’s home.

My cousins, my brother and I would each get to open a gift at my grandmother’s house.

More often than not, it was pajamas.

We would all go home late at night, our bellies full, our eyes heavy, and snuggle into our new pajamas to wait for Christmas morning.

There was a worn-out excitement to the whole night. A four-hour sugar rush doesn’t wear well when you’re that young.

This year has a very similar feeling — in the investment world, that is. I don’t normally gorge myself on Christmas cookies and fudge anymore. What I mean to say is that it feels like everybody’s frantically buying this year.

I’m just not completely sure that this enthusiasm is real. It could just be a four-hour sugar rush…

The U.S. Economic Sugar Rush

I don’t mean to be a downer. This year the markets have staged an amazing comeback. The Dow should close the year up 10% at least, with the S&P 500 scoring even higher at 12% or more. The Nasdaq was the real star: up about 18% in the past 52 weeks.

Heck, the S&P 500 is now at its highest level since the fall of Lehman Brothers two years ago!

These are great numbers. Businesses are becoming flush with cash again, and this could lead to more hiring and a welcome down-tick in our unemployment rate.

I sure hope so.

We need the private sector to get back invested in the U.S. economy, with jobs, preferably. That’s what the main problem was with nearly all the stimulus packages that tried to keep our head above water: the companies did little with the money they were given.

In Barbarians of Wealth, Sandy Franks and I talk about this issue:

But if the Fed has increased the money supply, where is it?

The answer is that banks and corporations are hoarding cash at levels not seen in years. The 30 companies making up the Dow Jones Industrial Average saw cash holding rise from $279 billion to $498 billion from 2008 to 2009. That’s a 79 percent increase in cash holdings.

You can’t really fault these institutions, though, can you? After all, it’s very natural to want to hold onto cash in times of economic crisis. The American people have done it themselves. Savings rates soared during the recession.

I, for one, would have wanted to see that money put to use, such as creating jobs, and investing in small businesses. It would be the responsible action…

How does this translate to today’s situation?

Well, we’ve still got an extremely high unemployment rate, and our debt burden is starting to worry even the most obtuse economists. And while we’re technically not in a recession, our growth rate is not strong enough to make a significant dent in either concern for at least another two to three years.

Are these businesses that are seeing greater cash flows going to start hiring, or continue hoarding?

That’s what the U.S. economy will hinge on.

Companies have learned to be more productive with fewer employees and lower costs, but there will come a point when productivity will level out without adding more workers. That’s the good part about this year’s shopping frenzy — it might entice some businesses to hire in 2011, if they see this strong demand continuing.

That’s a big “if”…

Interestingly, there are two things happening in the market: bond investors are headed for the hills, and gold investors are sitting on the sidelines.

From Bloomberg:

U.S. bond funds experienced withdrawals of $8.62 billion in the week ended Dec. 15, up from $1.66 billion the week before, according to a release from the Investment Company Institute, a Washington-based trade group. Last week’s withdrawals were the largest since the week ended Oct. 15, 2008, when investors yanked $17.6 billion from bond funds.

And gold trading is experiencing low volumes that are likely to continue into the new year. Some analysts are predicting a correction.

These two bits of information may mean that investors are getting back into stocks.

As we’ve said here in Smart Investing Daily, bullish investments should be hedged somehow in your portfolio, be they with a small put option, an allocation of precious metal, or some other protective measure.

It’s only prudent until the U.S. economy really starts gaining traction.

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