Archive for May, 2019

“Credit positive activities,” A Short-lived Phenomenon

According to a Moody’s analysis of 100 large companies, after an initial round of “credit positive activities,” notably debt reduction, following the corporate tax cuts in the 2017 overhaul, firms have shifted their attention to stock buybacks. The tax cuts increased corporate cash flow by almost $400 billion in 2018. Of that increment, 37% went to debt reduction in the first half; that fell to 14% in the second half. Just over a third, or 36% went to share repurchases in the first half; in the second half, that soared to 60%. Capital spending’s share went from 22% in H1 to 20% in H2.

The first half’s gross debt paydown exceeded gross borrowing, making for a net reduction in debt outstanding. In the second half, however, firms returned to net borrowing (though at a rate considerably below 2016 and 2017).

Shifting the focus from the uses of the tax cut gusher alone, firms devoted 49% of their total cash outflow to capex in 2016–2017; that fell to 41% in 2018. But the share devoted to buybacks went from 25% to 31%.

Moody’s report pairs nicely with a new NBER working paper by Daniel Greenwald of MIT, Martin Lettau of Berkeley, and Sydney Ludvigson of NYU, “How the Wealth Was Won: Factors Shares as Market Fundamentals.” They find that between 1989 and 2017, $23 trillion in real equity wealth was created by the nonfinancial corporate sector. More than half, 54%, of that increase “was attributable to a reallocation of rents to shareholders in a decelerating economy.” (To be specific, those rents were reallocated away from labor.) Economic growth accounted for 24% of those gains, lower interest rates for 11%, and a lower risk premium, also for 11%. By contrast, between 1952 and 1988, less than half as much wealth was created, but almost all of it, 92%, can be attributed to economic growth. Conventional estimates of the equity risk premium are, by their work, overstated by 50%.

Unlike many models of stock returns, rather than imagining a single representative agent, Greenwald et al. divide the population into shareholders and workers—in line with a world where the top 5% of stock wealth distribution owns 76% of total stock market value. Shareholders earn relatively little of their income from labor, and workers earn almost all of theirs that way. In this model, shifts in income from labor to capital, which play no role in the traditional valuation literature, have a significant explanatory power over stock market returns. A reminder that two of the three authors of the paper are business school professors and not freelancing Bolsheviks.

What about the low interest rates of recent years? The authors find they explain little of the stock market’s rise since the financial crisis. While real rates are low by the standards of the 1984–2000 period, they’re not by the standards of the 1950s through the 1970s.

Greenwald et al. do not address buybacks specifically, but they certainly fit in with the distributional shift towards shareholders in their model.

Philippa Dunne & Doug Henwood

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Longview: ECI

You might think a sub-4% unemployment rate would be nudging the employment cost index (ECI) higher, but it’s not.

In the first quarter, private sector compensation costs were 2.7% at an annual rate and were also up 2.7% for the year. That yearly gain was the lowest since the end of 2017. The softening was led by benefits, up 2.1% in the quarter and 2.4% for the year. Wage growth accelerated some, but still isn’t much above where it was at previous lows on the graph. And growth in overall compensation costs is also around the level of earlier lows. Wages remain the dog that didn’t bark.

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NIPA review

There were some huzzahs over the first quarter GDP number. The 3.2% quarterly rate, while still below two of 2018’s quarters, was at the upper end of its recent range. And the yearly rate, also 3.2%, was the best in almost five years. But the quarter’s numbers do nothing to close the gap with the long-term trend, and the composition of growth was unimpressive.

As the graph below shows, actual GDP remains well below its 1970–2007 trendline, which is based on an average of 3.2% growth. Since 2019Q1 just matched that average, the trendline remained just as distant. GDP is now almost 17% lower than it would be had the 3.2% average prevailed after the Great Recession. That gap works out to a deficiency of almost $5,000 in per capita terms, which, given long-term relationships, works out to about $3,800 in after-tax personal income. Consumption is 16% below trend; nonresidential fixed investment, 15% below; residential investment, 40% below; and government, 20% below.

And important components of GDP sagged badly in the quarter.

Consumption contributed just 0.8 point to real GDP, less than half what it did the previous quarter, and well below the average for both this expansion and the average of all expansions between 1949 and 2007. The contribution of goods consumption was negative. Nonresidential investment was weak, with both equipment and structures contributing nothing, and only intellectual property making any contribution. Residential investment was a drag on growth. Imports were weak, which is actually a positive contribution to growth, since they’re counted as a subtraction from GDP, but it’s not a sign of strong domestic demand. Inventory investment—which was 0.6% of GDP in nominal terms, twice the average since 1980—contributed a hefty 0.7 point to the headline growth number.

But the headline number did look pretty decent.

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