Corporate releveraging is set to become the next mega-trend in financial markets – replacing current themes such as double-dips or quantitative easing, says Jeffrey Palma, global strategist at UBS.

He acknowledges that this view will be met with scepticism given the recent financial environment. But Mr Palma points to an “unsustainable trinity” of factors suggesting the time is ripe for a shift in market expectations.

First, he says, corporate balance sheets are in rude health. “When compared to profits, debt levels are near 30-year lows – and global cash balances are equivalent to 12 per cent of market capitalisation.”

Second, companies must defend their return on equity. “This may seem counter-intuitive given the general rise in profitability in recent years, but we don’t think profit margins will expand further. The only lever remaining is leverage.

“Finally, the financial incentive is there, too. The spread between the cost of equity and debt finance is at its widest for a quarter of a century.

“We are at a critical point in the releveraging outlook. Investors should expect a rise in dividends, share buy-backs, merger and acquisition activity and capital expenditure. These shifts also point to an expansion of price/earnings multiples after years of compression, leading to equity market outperformance relative to both government bonds and corporate credit.”

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