Relevant and even prescient commentary on news, politics and the economy.

Stock Buybacks and the Equity Premium

Update 1 pulled up here (Dean Baker says current dividends plus share buybacks are unsustainable)

Update 2 Nick Bunker considers the dramatic example of Apple and the issue of unsustainable payouts to shareholders.

The point of this post is to try to estimate the sustainable long run expected real return on US common stock. Historically, the long run average return has been roughly 7% per year vastly greater than the safe real interest rate. This means that over all historical 30 year periods, US common stock has yielded a higher return than bonds. However, price earnings ratios are much higher than they were for much of the 20th century, so it doesn’t seem plausible that common stock could pay 7% real per year over long periods starting now.

Dean Baker challenged economists to come up with a story for how they could forecast 7% real returns (I can’t find the link). OK so I will.

First I will assume that the ratio of market capitalization to GDP won’t have a long term trend. US Real GDP growth has averaged about 3% per year since 973, so I assume that the value of the stock market will grow about 3% per year. Currently the S&P 500 dividend yield is about 1.9%. I guess (but don’t find the numbers) that the overall market dividend yield is higher, so I use 1.9%. So far I have 4.9% real return, well below 7%.

However, holding the market also requires buying newly issued shares and selling shares when corporations buy them back. In the USA corporations buy more shares from households than they sell — share buybacks are greater than public offerings. Net selling to the corporate sector is an additional source of returns. Share buybacks have recently been massive involving more dollars than were paid in dividends.

stock buybacks—more than $6.9 trillion of them since 2004, according to data compiled by Mustafa Erdem Sakinç of The Academic-Industry Research Network. Over the past decade, the companies that make up the S&P 500 have spent an astounding 54 percent of profits on stock buybacks. Last year alone, U.S. corporations spent about $700 billion, or roughly 4 percent of GDP, to prop up their share prices by repurchasing their own stock.

Last year’s buybacks were about 3.3% of market capitalization.

The reader may have noticed that I wrote “public offerings” not “initial public offerings”. It is possible for an existing joint stock corporation to issue new shares diluting the old shares. This is very tightly regulated and is very rare in the USA. Google keeps sending me to IPO when I ask for public offerings, so I will guess that recently all US public offerings were initial public offerings. IPO volume is much higher when share prices are high. Also 2014 had an extraordinarily high level compared to the rest of the past 10 years. That level was $ 85.2 billion less than 13% of the volume of share buybacks. I will assume that 2014 is the new normal and subtract 0.4% per year to pay for newly issued shares.

So my final back of the envelope guess of likely long term real returns is 7.8% per year*.

It seems to me that the equity premium is alive and well.

*arithmetic corrected.

update: Dean Baker responds. I like his post except that the title includes “Robert (not Paul) Waldman” which makes me think of “Robert (not Paul) Samuelson” and I sure hope Robert Waldmann isn’t to Paul Waldman as Robert Samuelson is to Paul Samuelson.

He pointed out that stock buybacks plus dividends of 5.2% of market capitalization are more than 100 % of profits (currently almost exactly 5% of market capitalization). To invest in physical capital (as they are) corporations have to be spending their financial assets or borrowing. This isn’t sustainable.

I am convinced. With a price earnings ratio of 20, there can’t be a dividend plus share buyback yield of 5.2% *and* growth of 3% without increased leverage and leverage can’t increase forever.

My tired front of the envelope guess is that with corporate debt equal to book equity (about right) both real fixed capital (K) and real debt growing at 3% per year, and no trends in relative prices, the ratio of reinvested profits to fixed capital has to be 1.5%. Here the calculation is increased real debt for a fixed debt/K ratio pays for half of the growth of K.

Market capitalization is somewhat greater than but roughly equal to nonfinancial assets so I think balanced growth of 3% per year requires a ratio of reinvested profits to market capitalization of somewhat less than 1.5%. So with a earnings/price ratio of 5% profits available for buybacks and dividends are about 3.5% and the sustainable return for everything balanced is about 6.5%.

For growth = 2% not 3% the sustainable return would be about 6%.

Comments (22) | |

Game Theory and the Filibuster

Ed Kilgore, who is not a hypocrite, still advocates limited use of the filibuster even now that Republicans have a Senate majority. He wrote

The filibuster has always been a monstrous but mitigated abuse—monstrous in its antidemocratic pretensions but mitigated by rare use. I see little reason for its use right now when the president has the power to veto any legislation that might succumb to a filibuster. And even if the power to filibuster is formally preserved, this would seem to be an ideal time to get out of the habit of deploying it.

I basically agree with him. In particular, I think Democratic Senators should end the filibuster of the motion to open debate on the bill to fund DHS and forbid DACA and DAPA act (Obama’s immigration executiver orders).

However, I can make an argument that the veto isn’t always as good as a filibuster. The reason is that, in game theory, but also in reality, timing can matter a lot.

I don’t think that, so long as a Democrat is in the White House, Democrats can’t derive any benefit at all from the filibuster. With must pass bills, timing matters. Congress can send the President a bill to, say, raise the debt ceiling and repeal Obamacare. If there really isn’t time to pass another bill before the US defaults, this is a take it or leave it offer. In bargaining timing is critical — the last mover has almost no bargaining power.

I don’t think the current filibuster is such a case. Democrats can allow DHS funding to lapse. This is unfair to the many DHS employees who will be required to work and wait to be paid later. But Republicans in Congress will bear most of the blame.

Again, I agree with filibuster restraint. I would support simultaneously eliminating the filibuster and eliminating the debt ceiling. I guess that, on balance, I would support eliminating the filibuster even without eliminating the debt ceiling.

But wait there’s less. Even less reason to filibuster than Kilgore suggests. Consider the filibustered motion to open debate on the House fund DHS and no deferred action fof DREAMERs resolution. The CBO has scored the bill as adding to the deficit (via Kerry Eleveld). Therefore, according to Senate rules it is out of order. If even one senator raises this point of order, to pass it would require a waiver of the rules which would require 60 votes. There is no need to use the filibuster in this case. PayGo will do just as well.

Comments (3) | |

Federal Reserve SOMA Holdings of the Long Bond

It is well known that the Federal Reserve in its three rounds of QE (and especially the first two) aggressively bought Treasury Notes and Bonds or collectively the ‘Long Bond’ of 10 Years and longer. But there has been relatively little discussion of what that means for such things as Federal Government Net Interest etc. So rather than advance my thoughts I figured we could start with the numbers in the following web tool:
System Open Market Accounts

The link should take you to the Summary Tab which shows that total holdings in these accounts are $4.221 trillion comprised of $1.738 trillion of MBS’s (Federal Mortgage Backed Securities) and $2.347 trillion in Treasury Notes and Bonds plus some smaller amounts in TIPS and Agency Securities that are more a rounding error in context. Of interest is that the Fed’s SOMA holds no T-Bills at all. That is the holdings are all Medium to Long (2 years and longer) and not Short (1 year or less).

If you click on the Notes and Bonds tab you will see a breakdown of Fed SOMA holdings of each issue. Now while Notes and Bonds are not individually labelled it is easy to distinguish 10 Year and shorter Notes and 30 Year Bonds simply by inspection of the relative coupon rates of different Treasuries maturing on the same date: rates above 6% being Bonds issued 15, 25, and 30 years ago and rates in the 1-3.5% range being mostly 10 Year Notes. If we then inspect Fed holdings of those higher yield Bonds we see that they comprise up to but never exceeding 70% of the total issue.

I’ll let you all inspect the Tables as you will but would like to ask a question. The numbers show that the Fed’s SOMA holds something like 2/3rds of ALL existing high yield Treasury Bonds. Which means that these accounts are also collecting that percentage of projected Net Interest going forward for that part of Federal Debt actually held in Bonds. Since the Fed has no need to ever sell those holdings against its will and can simply hold them to maturity and since it rebates ‘profits’ to Treasury this would seem to mean that simply examining Net Interest in either nominal terms or as a percentage of GDP will lead one to erroneous conclusions about the ability to the Government to service its debt. That is just examining the total for Public Debt and taking its average coupon doesn’t do much until or unless you segregate out both Intragovernmental Holdings AND the Fed’s SOMA holdings and THEN adjust for the fact that these holdings include up to 70% of the highest yielding instruments.

I have put up these numbers before but as usual had the comment threads hijacked into other channels (cough, cough **Social Security** cough). But I really really hope SOMEBODY will address these issues more directly in terms of macro finance.

Tags: , , Comments (18) | |

“Generational Accounting” Is Complex, Confusing, and Uninformative

Well yes it is, and something of a constant theme of mine here at Angry Bear. But here is a chance to read the argument in the hands of real experts at CBPP, including Paul Van de Water who formerly held top positions at both SSA and CBO and is kind of a mentor of mine.

“Generational Accounting” Is Complex, Confusing, and Uninformative

CBPP is the Center for Budget and Policy Priorities and is along with EPI the Economics Policy Institute and CEPR Dean Baker and Mark Weisbrot’s Center for Economic Policy and Research the three go to places for progressive policy numbers presented in rigorous form. While they shouldn’t be blamed for some of my policy formulations over the last few years, these are the places I mostly get the ideas for what I call my “number pointing” (as opposed to “number crunching” which I leave up to Paul, Kathy, Monique and Dean).

Tags: , , Comments (39) | |

Open thread Feb. 9, 2014

Well, my west of Boston town has had about 75 inches of snow in the last couple weeks.  Any one have stories??   I believe Kenneth Thomas has moved to Boston a week or so before the storms, and “what a welcome!” pops into mind  for someone from the St. Louis area.

Comments (3) | |

Does Clinton Really Have People Around Her Who Think Elizabeth Warren Is a Man? Yikes.

Some people around Clinton assume that any skepticism about her candidacy has to do with latent sexism, but I’m pretty sure that’s not my issue, either. Last week, my 6-year-old daughter informed me that she couldn’t be president because she’s a girl. So believe me, if Hillary Clinton takes the oath of office on the third Friday of 2017, we’ll be watching together.

My problem with the Clinton Death Star, Matt Bai, Yahoo News, Feb. 5

We’re in trouble, Dems.  Big trouble.  We’re about to nominate as our presidential candidate someone who, if Bai’s reporting is accurate, has some people around her who think that the Draft Elizabeth Warren movement isn’t about the economic populist issues and policies that Warren stands for, but instead that Elizabeth Warren is a man.

Advice to Clinton: Fire these people. Immediately.

Tags: , , Comments (21) | |

Zero Lower Bounds

These are the usual confused thoughts mostly stimulated by this excellent post by Simon Wren-Lewis

You really should click the link and read that post. I will try to summarise it.

First professor Wren-Lewis argues that monetary policy would not have offset less contractionary fiscal policy in the past 6 years, because short term safe nominal interest rates were stuck at the zero lower bound. Second, he argues that “For whatever reason (resistance to nominal wage cuts being the most obvious), inflation ceases to be a good indicator of underutilised resources when inflation starts off low and we have a major negative demand shock. ” So the not at all absolute zero lower bound on changes in nominal wages matters too.

The problem with the argument that nominal interest rates can’t be negative is that they are in Denmark and Switzerland. The logic was that interest rates on bank notes can’t be negative so negative interest rates on other assets can only equal the cost of holding wealth as cash in a safe. It turns out that these costs make negative interest rates possible. I don’t think this matters all that much. Cash in a box arbitrage still implies that there is a lower bound which is no higher than -1% per year (and might be lower but it exists). It also does not imply that looser fiscal policy would have been offset. If central bankers believe there is a zero lower bound and they are stuck at it(as the Federal Reserve board and the Bank of England did) will not raise interest rates above zero following any increase in aggregate demand. I don’t think recent market rates in Switzerland and Denmark refute the whole liquidity trap argument, but I do think that Krugman, Wren-Lewis and others (including your humble correspondent) have to consider the issue a lot more.

There is another, much less valid alleged zero lower bound. It is argued by, for example Jeremy Stein that safe interest rates of at least 2% are needed for banks to make profits without taking risky gambles. It is assumed that such gambles can’t be prevented by prudential regulation, so we have to pay them 2% protection money or else something might happen to the nice economy we have here. But the argument is that the cost of maturity transformation and such is 2% per year and it is just assumed that banks can’t (or won’t) charge depositers. That the worst deal a bank can offer me is the convenience of a checking account for zero interst. This is nonsense. I can’t get a deal that good from either of my two banks (including SunTrust which promised me exactly that deal, but has charged me fees). Banks can charge for the convenience. Italian banks have always done this. The zero lower bound on checking accounts is like the zero lower bound on nominal wage changes. It isn’t a no arbitrage condition, it is a norm. I can agree that bankers won’t drive off clients by charging fees because providing zero interest zero fee checking is temporarily unprofitable. But if it is agreed that they are willing to accept a little red ink, why is it assumed that they can’t be kept from making reckless gambles to avoid it ?

Comments (11) | |

An Act of Kindness – The Rest of The Story

I was never aware of what impact I had over the years in my family until my youngest son reminded me of what I had done on an evening in a store called Woodman’s located on the west side of Madison, WI. I was out of work and I was busy supplementing my income by gaffing up trees, cutting them down, and chipping wood. A job not requiring a lot of intelligence for a man with 4 degrees. I was deadly tired each day.

My 8 year old young son and I were waiting in line to check out with our groceries. The man in front of us had a loaf of bread, a half gallon of milk, and peanut butter. The cashier rang him up and gave him notice of what he owed. He plopped down his money and they stared at each other for the longest 15 seconds I ever experienced. He was short cash to pay. As the cashier reached into her pocket to pay the difference, I dropped a dollar on the conveyor. She took it and he left just taking a moment to look back at us. 25 years passed and my youngest son Craig in a conversation reminded me of what took place that day of something I had long forgotten. It was not important to me; but, my actions had an impact on him.

What makes this story in the picture interesting on USA Today and Crooks and Liars is an adult white male taking time to teach a young black male how to tie a regular tie as opposed to using a clip-on tie. The young man was scheduled to interview for a job and he needed to look the part. The Target employee took the time to teach how to and tie the tie as there were no clip-on ties at Target besides tutoring the young man in answering questions a prospect employer might ask him. Do you believe this young black male will remember the kindness an adult male showed him one day? Furthermore, is it possible in the future this young male might return a moment of kindness to another person who may need his help as a result of one person taking the time to help him regardless of gender, age, religion, and hue of skin? I am sure he will remember.

Perhaps, this gesture is little more than a person who sees the other as a person of equal stature and makes the effort to reach out with a moment of kindness.

Tags: Comments (7) | |