Barron’s magazine this weekend ran an interesting analysis of capital arbitrage that is still having significant impact on financial markets. What is this “arbitrage”? Low interest rates of the past several years have provided corporations and investors a low cost source of funding to make acquisitions, share buybacks and dividend increases; it is using debt to enhance shareholder returns (ROI).
What’s the point? Corporations believe they can achieve a better return for shareholders through capital arbitrage than through capital spending. We note that a similar “capital arbitrage” process occurred in the 1978-1985 period, which laid the foundation for a major secular bull market that began in 1982. We believe the similarities of today vs. 1978-85 are important and have positive implications for the stock market going forward.