Who helped corporate rich get richer? You did

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Tom Petruno
In the banking industry in 2009, the rich got richer -- which has, of course, infuriated much of the nation.

But that same basic idea, mostly minus the public infuriation factor, is playing out across the business world.

The Great Recession has killed untold numbers of small firms, many of which were unable to line up financing to keep their operations afloat.

But money is no problem at all for corporate America. And the biggest businesses don't need banks, at least not for loans. As the credit crisis has eased, they've been able to turn to the welcoming arms of the bond market.

Recessions always are about the weak falling away while the strong survive. But this time around, the credit crunch has remained so severe for smaller firms that the advantage has been magnified for the major companies that have unfettered access to cash via bond sales.

Issuance of high-quality (i.e., investment-grade) bonds reached a record $2.83 trillion worldwide last year, a stunning 38% jump from 2008, according to data tracker Dealogic. Although governments were heavy borrowers, about half of that total raised was by big-name companies.

Who helped make the corporate rich even richer? You did -- if you're one of many Americans who pumped your savings into bond mutual funds. An unprecedented $375 billion poured into bond funds in 2009, providing a significant chunk of the capital that then flowed into newly issued bonds from companies such as General Electric Co., Pfizer Inc. and Dow Chemical Co.

And like any symbiotic relationship, this one has no good reason to end. While many investors now shun the stock market, their hunger for income may keep demand for corporate bonds strong in 2010 and beyond.

A bond is a promise to pay -- first, to pay a rate of interest each year, and second, to repay the investor's principal when the bond matures on a set date, if not before. Understandably, after the financial markets' crash of 2008, a promise to pay sounds a lot better to shell-shocked investors than taking a flier on a stock.

For a company like GE or Pfizer, bonds offer a way to raise large sums of cash at set interest rates. Those rates were declining for much of 2009 as fear subsided in financial markets and as investors bid aggressively for fixed-income securities.

It isn't just the Fortune 500 that can borrow through bonds, but this isn't a market that's open to the millions of small firms that have been the most starved for credit over the last 18 months.

Last year, the massive sums raised from corporate bond sales allowed some companies to pay off bank loans or bonds previously issued at higher interest rates. Others used the money to finance takeovers. And some firms just built up their cash reserves to bolster their finances.

The amount of cash on the balance sheets of the industrial companies in the Standard & Poor's 500 index soared to a record $820 billion as of Sept. 30 from $647 billion a year earlier, according to S&P.

Because cash pays nothing, big companies should be feeling pressure to put those dollars to more productive use -- say, by expanding.

But we live in a still-struggling global economy that already has too much vacant office space and too many idled factories. "Who needs more capital goods or structures with 15% excess capacity lurking in most economies?" said Carl Weinberg, chief economist at High Frequency Economics in Valhalla, N.Y.

Likewise, many big companies believe they have no need for additional workers, which is why double-digit unemployment has become the black cloud over the economic recovery of the last six months.

Yet even in the best of times, the Fortune 500 aren't engines of job growth in the U.S. "Almost all of the new jobs and investment in any economy come from small companies morphing into larger ones," Weinberg notes. "If they get squeezed, the economy loses its dynamism."

That's one of the great long-term risks the U.S. faces from the corporate-rich-get-richer syndrome that bond investors are abetting. If capital is being misallocated -- meaning, if its most productive use would be with smaller companies, except that they can't get into the bond market and they can't get loans from banks -- the economy can't live up to its true potential.

While corporate titans benefited from the bond market's largess last year, many also have been reaping the rewards of the ruthless drive to reduce head count and slash other costs. Even modest growth in sales now is falling directly to the bottom line.

The result: Fourth-quarter earnings reports from the S&P 500 index companies are coming in far above Wall Street analysts' expectations. Of the 220 companies in the index that have reported results so far, 78% have beaten estimates, according to data firm Thomson Reuters. And on average, earnings have been 17% above expectations -- a "surprise" factor that, if it holds up, would be the highest for any quarter since Thomson Reuters began tracking data in 1994.

It could be that analysts, more than usual, are lowballing their estimates to make it easier for companies to post pleasant surprises. Still, there's no question that earnings have improved dramatically for the biggest firms.

That profit rebound should be good news for stock prices, and it was for much of the last 10 months. But the equity market has hit an air pocket over the last two weeks.

On Friday, the Dow Jones industrial average lost 53.13 points, or 0.5%, to 10,067.33, its lowest since Nov. 6. The Dow has slid 6.1% from its 15-month high of 10,725 on Jan. 19.

Despite the government's report Friday that the economy expanded at a strong 5.7% annualized rate in the fourth quarter, there are more questions now than even a few weeks ago about the sustainability of the recovery.

If those doubts grow, Wall Street could face another downdraft. And if investors grow warier of stocks, they may turn in even greater numbers to the relative safety of high-quality corporate bonds.

One unusual twist in the bond market this year is that global investors may have reason to feel more secure in bonds of mega-companies than in bonds of some foreign governments. This week, worries about Greece's dire fiscal situation also infected other Southern European countries. Investors pushed yields on Greek, Portuguese and Spanish bonds sharply higher, a sign of eroding faith in the countries' creditworthiness.

Mark Kiesel, who manages the $6.5-billion Pimco Investment Grade Corporate Bond mutual fund in Newport Beach, says he's betting that many high-quality corporate bonds will continue to attract investors looking for decent annualized yields -- in the 5% to 7% range -- and balance sheets strong enough to weather a still-rough economy.

"Corporate America," Kiesel says, "is a cash-flow machine."

That isn't any solace to the unemployed, but it offers a level of comfort that is bond investors' No. 1 priority.