It came like a bolt out of the blue. Without any advance warning, one of my banks wrote to inform me that my complimentary overdraft facilities would be withdrawn with immediate effect. It didn’t bother me one iota, though. I never had to use the interest-free flexible loan anyway. But it got me thinking.
What if I was someone whose bank balances would, occasionally, dip into the red because the timing of cash inflows and outflows didn’t always dovetail as planned? What are they going to do if bills need to be paid but their monthly paycheques hadn’t yet arrived? Worrying doesn’t even begin to describe it.
So, why are some banks clobbering customers at a time when costs are rising and the outlook for the global economy looks desperately uncertain? Some of their customers might even lose their jobs without prior notice.
The answer should be fairly obvious to all of us. However, some might choose to ignore it. Thing is, credit conditions are tightening. But we don’t talk much about Quantitative Tightening otherwise known as QT. After all, interest rates are a far sexier topic. However, QT is gradually working its way through and slowly strangling the financial system.
The Fed, for instance, is committed to shrinking its balance sheet by withdrawing around US$1 trillion from the American economy this year. It is only halfway through applying the financial tourniquet. That could have a major impact on not only the US, but in other parts of the world, too. The removal of my overdraft facility is just one example.
So, at the risk of sounding insensitive, where are the opportunities for investors as credit conditions tighten, as interest rates stay high, and as global growth slows to the point of stuttering? The answer is credit and the providers of credit.
We need to look no further than banks who are ready to lend at the right price. Many observers, I have noticed, like to focus on interest rates and try to second-guess when those interest rates might peak. But let’s not forget that there is no one-size-fits-all interest rate for everyone.
Credit is priced according to the type of loan, who wants to borrow the money, and how long they need the cash for. Benchmark interest rates are, at best, just a guide. So, even though some observers think that interest rates may have peaked, it doesn’t necessarily translate to cheaper borrowing.
Thing is, we are still only at the start of the credit-tightening cycle, and many businesses are already squealing. Some have unfortunately gone to the wall. Many more could be forced to call it a day, too. Consequently, investors and lenders need to tread carefully.
We need to focus on cash and cash flow. That free cash flow provides companies with important options when credit conditions are tightening. They can use the available cash to pay down debt, pay off outstanding loans, buy back their shares, and even continue distributing it to shareholders.
It is all about cash – those who have it, those who can generate it, and those who desperately need it. Look for companies that can do the first two. That is where we will find investing opportunities. And avoid those that fall into the third category like the plague. As Buffett said “It is better to stay out of trouble than try to get out of trouble later.“
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