When the Stimulus Stops, Cash Flow Matters

Several rounds of massive stimulus by the Federal Reserve have kept interest rates well below where they might otherwise be, buoying both stock and bond markets. As stock prices have reached new peaks, many professional investors consider current valuations to be stretched. When the stimulus finally stops, a new era of rising interest rates will likely take hold. And experienced investors know that rising interest rates and high valuations and can be a dangerous combination.

Investors are already beginning to appreciate the weaknesses of a program that has essentially distorted the free market. Even the first mention of tapering the stimulus resulted in volatile price swings. As investors become increasingly aware that stimulus support won't last forever, caution has taken hold and they are re-evaluating positions in the stocks that they own.

At the beginning of the year, investors who were unable to find yield in the debt markets flocked to utilities and REITs, driving the valuations of these dividend-paying stocks to near all-time highs. As interest rates increase, these sectors will become less attractive and are likely to decline in value as conservative investors shift away from equity exposure in favor of bonds.

In a low interest rate environment, even low-quality companies can thrive, as they can finance operations by issuing debt at a relatively low cost as a means to potentially generate positive returns for shareholders. In contrast, in higher rate environments, businesses with less profitable operations are less likely to generate the same level of returns as they may not be able to afford to borrow the cash they need to operate.

As stimulus is withdrawn, equity managers and investors will turn their collective focus to companies whose strong balance sheets and high cash flow makes them attractive, even in an environment of higher interest rates. Given the current uncertainty around tapering, we expect that the steady cash flow of high-quality companies will prove to be an even more important factor than ever when evaluating stock investments.

The information contained herein is for informational purposes only. Any opinions expressed herein are subject to change without notice. The information does not constitute an offer to sell nor a solicitation of an offer to buy an interest in any Mesirow Financial investment vehicle(s). Any offer can only be made through the appropriate Offering Memorandum which contains important information concerning risk factors and other material aspects of the investment and should be read carefully before an investment decision is made. It should not be assumed that any opinions or recommendations incorporated herein will be profitable or will equal past performance. The Mesirow Financial name and logo are registered service marks of Mesirow Financial Holdings, Inc. Investment management services offered by Mesirow Financial Investment Management, Inc., an SEC-registered investment advisor. Securities offered through Mesirow Financial, Inc. member NYSE, SIPC.

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