Details are slowing coming out of a possible agreement on a new fiscal stimulus. It is a smaller package, but, nevertheless, if it passes, is still substantial as it pertains to direct household (HH) assistance which is what matters to the stock market. The UI benefits + the direct government transfers in the previous package covered more than 200% of the lost income from unemployment during March-September. As a result, total HHs savings rose by about $1.4Tn in that period. A chunk of that money went into financial assets, including stocks, judging from anecdotal evidence and data from retail brokerage accounts.
Most of the extra UI benefits have now stopped and the government transfers are smaller. However, they are still able to cover lost income from unemployment even as of September. Without a new deal, though, that won’t be possible in October, which means that HHs might have to tap into their savings to supplement their income. Which might mean, they have to sell stocks.
Reality, though, is that the majority of that $1.4 of extra savings, up to now, was skewed to the people who do not live pay-check to pay-check and, therefore, going forward, 1) most US HHs would be in big trouble to cover expenses without a new stimulus deal, and 2) there might not be a substantial flow of equities selling pressure from reduced savings even if there were no new deal.
So, that is why a new fiscal stimulus is likely coming, despite, seemingly, no need for it, given elevated HHs savings. In fact, the amount of HH savings is slowly turning into a similarly giant money cemetery as that is what the excess reserves at the Fed are: money which does not enter the ‘real economy’, rather it might remain stuck, ‘forever’, in financial assets.
So, even with the reduced UI payments ($400 vs $600) and reduced direct transfers ($1000 vs $1200), the money should be more than enough to cover the lost income from unemployment. A rough calculation from the article above shows that UI benefits + direct government transfers would amount to $500-600Bn for September – December. The previous package came to a combined $800Bn for April – August (see here).
Which means there will be even more money going into savings and thus financial assets. With monetary policy on autopilot until 2023, all marginal financial liquidity, ironically enough, courtesy of the extremely skewed income distribution in the US, is now solely determined by fiscal. From a pure flow perspective, in the short term, stocks should like this status quo (economy/employment weaker) more than a rebound in economic activity.
Longer term, post the election and into 2021, a Democratic sweep might increase the risk of higher corporate taxes/regulations which will eventually weigh on corporate cash flows. But it might also increase the likelihood of future, and more generous, stimulus packages, and even perhaps, eventually, a UBI.
So, I have been doing a bit more work on trying to quantify US fiscal response to Covid-19 on US household income, consumption, savings and the stock market. Most of the data, I have been using, is from BEA Table 2.6; some is from the BLS employment/compensation report. The complete data set is only updated to July, unfortunately, but I have done projections for August and September where necessary. We will get the new data set on October 1, in a few days.
Bottom line is that without a new fiscal deal, US households will start digging into accumulated substantial savings to cover losses from unemployment which will prop up consumption but, most likely, expose the stock market to the downside.
We all know that Covid-19 produced an employment shock comparable only to the Great Depression: there are still some 11.5m fewer people, or so, not employed vs to pre-Covid. The surprise (to me) was the fact that there was a 4.5% jump in weekly compensation, MoM, from February to August this year. This, on its own, cushioned a bit the overall purchasing power of the private sector.
As you can see, actually, personal income did rise immediately after Covid, and is still some 5% higher from February this year. However, for sure it was not due to a rise in employment compensation (# people employed x wage rate,) despite the rise in weekly wages (see previous chart). In fact, overall compensation is still down almost 5% from February.
The reason HH income rose, was active fiscal policy which substantially increased UI Benefit and other government transfers post Covid. The annualized numbers exaggerate a bit this, but, nevertheless, the size of the increase is beyond anything previously done and also more than offsets the decline in employment compensation (see further down).
So, what did HHs do with the extra money? Well, they did not spend them: consumption is still down about 5% from February. HHs’ savings, on the other hand, rose substantially in the meantime.
The table below breaks HHs’ cash flows net of their level from before Covid, and it is also on a monthly basis, so it is easier to see how the lost income from unemployment is more than offset by the unemployment insurance benefit payments. Then, on top of that, we’ve had further government transfer payments as part of CARES Act. No wonder the savings rate is so high!
Here is a snapshot of the same table netting off just the employment vs the benefits/transfer flows. US HHs had a negative cashflow only in March. Since then, they have net received income despite the high unemployment rate. Even in August and September, the loss income was more than offset with UI Benefits (not sure how that is possible as the UI payments stopped in July but that is what the data shows).
But both the UI payments and the government transfers are winding down. In October, US HHs might just about break even as employment compensation might not jump up to offset them.
The good news is that HHs have a very large cushion of savings on which to draw on, an extra $1.4Tn (this number also cross-references with Fed H.8 report on bank deposits). So, if anything, the economy would probably be fine. The bad news is that, to an extent that those savings were invested in the stock market, asset prices might find it difficult to rally.
So, there are two conclusions to be made. First, the extent of the fiscal support to the stock market in the past five months is not to be underestimated: if anecdotal evidence and data from retail brokerages are taken together, a big chunk of the households savings was invested in stocks. The fact that government assistance was still bigger than lost gains from unemployment in August (despite the expiry of some UI benefits in July) explains why the stock market remained bid throughout the month.
Second, the pressing need to pass the next phase of the fiscal stimulus is not to save the economy so much, but to save the stock market. Households have amassed about $1.4Tn of extra savings post Covid. As government assistance cannot cover the lost gains from unemployment going forward, without a new fiscal stimulus, some of that savings will most likely be re-directed from stocks to consumption leaving the stock market exposed to the downside.
At $3.2Tn, US Treasury (UST) net issuance YTD (end of June) is running at more than 3x the whole of 2019 and is more than 2x the largest annual UST issuance ever (2010). At $1.4Tn, US corporate bond issuance YTD is double the equivalent last year, and at this pace would easily surpass the largest annual issuance in 2017. According to Renaissance Capital, US IPO proceeds YTD are running at about 25% below last year’s equivalent. But taking into consideration share buybacks, which despite a decent Q1, are expected to fall by 90% going forward, according to Bank of America, net IPOs are still going to be negative this year but much less than in previous years.
Net issuance of financial assets this year is thus likely to reach record levels but so is net liquidity creation by the Fed. The two go together, hand by hand, it is almost as if, one is not possible without the other. In addition, the above trend of positive Fixed Income (FI) issuance (both rates and credit) and negative equity issuance has been a feature since the early 1980s.
For example, cumulative US equity issuance since 1946 is a ($0.5)Tn. Compare this to total liquidity added as well as issuance in USTs and corporate bonds.*
The equity issuance above includes also financial and foreign ADRs. If you strip these two out, the cumulative non-financial US equity issuance is a staggering ($7.4)Tn!
And all of this happened after 1982. Can you guess why? SEC Rule 10b-18 providing ‘safe harbor’ for share buybacks. No net buybacks before that rule, lots of buybacks after-> share count massively down. Cumulative non-financial US equity issuance peaked in 1983 and collapsed after. Here is chart for 1946-1983.
Equity issuance still lower than debt issuance but nothing like what happened after SEC Rule10B-18, 1984-2019.
Buybacks have had an enormous effect on US equity prices on an index basis. It’s not as if all other factors (fundamentals et all) don’t matter, but when the supply of a financial asset massively decreases while the demand (overall liquidity – first chart) massively increases, the price of an asset will go up regardless of what anyone thinks ‘fundamentals’ might be. People will create a narrative to justify that price increase ex post. The only objective data is demand/supply balance.
*Liquidity is measured as Shadow Banking + Traditional Banking Deposits. Issuance does not include other debt instruments (loans, mortgages) + miscellaneous financial assets. Source: Z1 Flow of Funds
Foreign selling starts to pick up also in US equities and agencies.
March broke the record for Total foreign monthly outflow.
This happened largely on the back of a record Private foreign sector outflow.
April still saw a large net foreign outflow, though not as big as March. Nevertheless, this time, the Official foreign flow reached an all-time low.
This is significant because the 12-month rolling cumulative total foreign flow in US turned negative by a large amount. This is very, very unusual.
Foreigners are still focused at the moment on selling primarily USTs.
While in the past, private foreign accounts may have bought USTs even when official foreign accounts were selling, in the last two months (April-March), private foreign money turned sellers in size. In fact, their outflows have been several times bigger than the official foreign account outflows. This most recent selling put the 12-month rolling UST private foreign flow in negative territory in March. It reached an all-time low in April. The 12-month rolling UST official foreign money flow is also close to its all-time record low, reached in November 2016.
On the US equities side, unlike in March, though, this time foreigners were net sellers. The total outflow was not that large by historical standards, but the official foreign outflow was.
Foreigners continued to buy US corporate bonds, especially official foreign money. Nothing new there.
Finally, on the agencies side, official foreign accounts were a rather unusual and large seller.
Conclusion: The continuous high level of total foreign US assets outflows in April is interesting and could herald a change in trend of previous USD inflows. We can see that by looking at the rolling 12-month data which turned negative in March and is accelerating lower. In theory, there shouldn’t have been any forced pressure on foreign accounts to exit US assets in April, as Fed/Other Central Banks swap and repo lines were already in place. If this continues, the USD may be in bigger trouble than initially thought. See here, here and here.
“General Motors Corp. filed for bankruptcy protection, got kicked off the New York Stock Exchange and out of the Dow Jones industrial average. And its stock has mostly been rising ever since. In fact, GM has been one of the hottest issues on Wall Street over the last six trading sessions, surging from 61 cents totoday’s closing price of $1.59 in the electronic pinksheets.com market – a gain of 161%. (…) As I’ve written before, there’s a universe of traders out there who love to play around with big-name stocks that end up in bankruptcy. You can’t explain the action based on any fundamentals. It’s just a minute-to-minute, hour-to-hour trading game. (…) We know how this will end. But between now and then, for some gamblers playing GM is better than a trip to Vegas.”
“GM’s stock keeps trading but it is probably worthless” Tom Petruno, Los Angeles Times, June 10, 2009
The price action in Hertz shares post-bankruptcy is quite normal (up to “Bankrupt Hertz granted approval to sell up to $1Bn in shares”, but that is another, important, story). The elevated activity of retail investors in trading the shares of bankrupt companies is a feature of this particular market. For a lot of them it ends badly, but most of them are doing it for the fun of gambling anyway.
I am not a bankruptcy expert or a bankruptcy lawyer and I have never been involved in a company restructuring (plenty of bond restructurings though). Let’s say that before Hertz, I knew nothing about bankruptcies. What I found fascinating with that recent episode, though, is that even people who should know about corporate bankruptcy (equity portfolio managers) did not know much either. I was intrigued by the Hertz case as it looked quite bizarre and indeed the price action seemed against all common sense.
As I embarked on researching the topic, it turned out that even the academic literature on this is quite scarce. Of course, there is a lot that addresses bankruptcy cases and issues but there is little on trading, valuations or performance of stocks which have entered bankruptcy. There are a few reasons for this perhaps. First, most bankrupt stocks are delisted from major exchanges before or around bankruptcy filings. Second, institutional ownership declines massively post-bankruptcy, with 90% of shares owned by retail thereafter. Third, research coverage drops as a result. And fourth, yes, the market for bankruptcy shares, it turns out, is quite inefficient, for example, very difficult to short (inability to source borrowing) and very wide bid-offer spread (all due to thin institutional involvement).
To do my research I relied extensively on two papers: 1. “Investing on Chapter 11 stocks: Trading, value, and performance” by Yuanzhi Li and Zhaodong Zhong 2. “Gambling on the market: who buys the stock of bankrupt companies?” by Luis Coelho and Richard Taffler. The below is my summary of some of the topics discussed in these as they pertain to markets.
There are quite a few misunderstandings about bankruptcy procedure. First, when companies get delisted, they don’t just disappear but continue to trade on the Pink Sheets, which is an electronic quotation system. Second, even though there are quite a few limitations, as mentioned above, trading activity is quite brisk. Third, it is quite common for prices to bounce immediately after bankruptcy announcements as institutional shareholders tend to choose to cover their shorts on the major exchanges than go through the Pink Sheets or indeed through the bankruptcy proceedings. Fourth, although in the majority of cases shareholders do get zero, there are precedents where shareholders gain, sometimes substantially, when buying the stocks immediately after bankruptcy announcements.
So, the fact that Hertz share price rose in these circumstances should not be a surprise given that the company was one of the most shorted stocks on the main exchanges for a number of years before. Moreover, it is quite common for share prices to rise immediately after declaring bankruptcy, even independent of short covering, on the back of a phenomenon called violation of APR (absolute priority rule) which occurs “when creditors are not fully satisfied before shareholders get any payments”.
There are two main reasons to do that. One is rational: there is value in buying cheap and deep out of the money call options on a company’s assets, operations, brand, etc. (some of them, some of the time, will pay off handsomely). There are examples of companies exiting bankruptcy with the original shareholders having gained from owning the shares from the day bankruptcy was officially announced.
The second reason is irrational. There is a massive non-linearity in the return: you get either zero or a lot. And who doesn’t like a cheap lottery ticket! The average price of bankrupt company shares is actually around $2 (yes, Hertz is well within that price range at the moment) in the month immediately post-bankruptcy, which to a lot of retail investors, looks, yes, irrationally, cheap.
“The human propensity to gamble seems to be able, at least partially, to explain why stocks of bankrupt firms continue to be actively traded by retail investor even after the formal announcement of bankruptcy.”
But don’t be deluded. There is only an ‘illusory profit opportunity’. The average return on holding the shares of bankrupt companies into the actual process of restructuring is a negative 28%. Limited possibility of short selling and not enough company disclosure, contributes to share prices reflecting a more optimistic scenario than actual reality and being much higher initially than, perhaps, ‘fundamental value’. That is why, there is a persistence of negative returns from a buy-and-hold strategy in bankrupt company shares: at the end of the bankruptcy proceedings, the true value of the stock is revealed. That does not mean though that buyers can not make money buying and selling the stock while still in the Pink Sheets.
Trading in the stocks of bankrupt companies whether immediately post-bankruptcy, as with Hertz, or in the Pink Sheets, is much more ‘suitable’ for retail investors, who, unlike institutional investors are more prone to overvalue risky assets and to prefer lottery-like payoffs. The current stock market activity, in general, was dominated by retail investors even before Hertz to an extent last observed probably during the dotcom boom. So, perhaps we are focusing too much on this phenomenon, and, in the process, exaggerating the effect retail investors have on the market, away from what that normally is.
Repo volumes are rising in a similar fashion to the beginning of the crisis in February. Liquidity is leaving the system. Last two days, repos (O/N and term) rose above $100Bn. S&P500 topped on February 19 while repo volumes were about half of what we are seeing today. By the time we hit $100Bn in repos (March 3), the index had dropped 10%.
We had about two weeks (March 3-March 22) of repos printing about $128Bn on average per day. S&P 500 bottomed on March 23 as the Fed started stepping in with its various programs. Repos went down below $50Bn on average a day. More importantly liquidity started flooding the system. Reverse repos skyrocketed from $5bn on average per day to $143Bn a day by mid-April! Equities rallied in due course.
April/May, things went back to normal: repo volumes between $0Bn and $50Bn a day and reverse repos averaging about $2-3Bn a day->Goldilocks: liquidity was just about fine. Equities were doing well. Then in the first week of June, repos jumped above $50Bn, and last Friday and today they went above $100Bn. Reverse repos are firmly at $0Bn: they have literally been $0Bn for the last 4 days.
Again, just like in February, liquidity is starting to get drained from the system. By that level of repo volumes in March, equities were already 10% lower from peak. S&P500 is just a couple % below that previous peak, but Nasdaq is above!
I am not sure why the market is here. It could be that, in a perfect Pavlovian way, investors are giving the benefit of the doubt to the Fed that it will announce an increase of its asset purchasing program at this week’s FOMC meeting. If it doesn’t, US equities are a sell.
And don’t be fooled by no YCC or any forward guidance. The Fed needs to step in the UST market big way. YCC on 2-3 year will do nothing. Fed needs to do YCC on at least up to 10yr. As to really address the liquidity leaving the system, Fed needs to at least double its weekly UST purchases.
Fed is now probably considering which is worse: a UST flash crash or a risky asset flash crash. Or both if they play their hand wrong.
Looking at the dynamics of the changes in the weekly Fed balance sheet, latest one released last night, a few things spring up which are concerning.
1.The rise in repos for a second week in a row – a very similar development to the March rise in repos (when UST10yr flashed crashed). The Fed’s buying of Treasuries is not enough to cope with the supply hitting the market, which means the private sector needs to pitch in more and more in the buying of USTs (which leads to repos up).
This also ties up with the extraordinarily rise in TGA (US Treasury stock-piling cash). But the build-up there to $1.4Tn is massive: US Treasury has almost double the cash it had planned to have as end of June! Bottom line is that the Fed/UST are ‘worried’ about the proper functioning of the UST market. Next week’s FOMC meeting is super important to gauge Fed’s sensitivity to this development
2.Net-net liquidity has been drained out of the system in the last two weeks despite the massive rise in the Fed balance sheet (because of the bigger rise in TGA). It is strange the Fed did not add to the CP facility this week and bought only $1Bn of corporate bonds ($33Bn the week before, the bulk of the purchases) – why?
Fed’s balance sheet has gone up by $3tn since the beginning of the Covid crisis, but only about half of that has gone in the banking system to improve liquidity. The other half has gone straight to the US Treasury, in its TGA account. That 50% liquidity drain was very similar throughout the Fed’s liquidity injection between Sept’19-Dec’19. And it was very much unlike QE 1,2,3, in which almost 90% of Fed liquidity went into the banking system. See here. Very different dynamics.
Bottom line is that the market is ‘mis-pricing’ equity risk, just like it did at the end of 2019, because it assumes the Fed is creating more liquidity than in practice, and in fact, financial conditions may already be tightening. This is independent of developments affecting equities on the back of the Covid crisis. But on top of that, the market is also mis-pricing UST risk because the internals of the UST market are deteriorating. This is on the back of all the supply hitting the market as a result of the Treasury programs for Covid assistance.
The US private sector is too busy buying risky assets at the expense of UST. Fed might think about addressing that ‘imbalance’ unless it wants to see another flash crash in UST. So, are we facing a flash crash in either risky assets or UST?
Ironically, but logically, the precariousness of the UST market should have a higher weight in the decision-making progress of the Fed/US Treasury than risky markets, especially as the latter are trading at ATH. The Fed can ‘afford’ a stumble/tumble in risky assets just to get through the supply in UST that is about to hit the market and before the US elections to please the Treasury. Simple game theory suggest they should actually ‘encourage’ an equity market correction, here and now. Perhaps that is why they did not buy any CP/credit this week?
The Fed is on a treadmill and the speed button has been ratcheted higher and higher, so the Fed cannot keep up. It’s a dilemma (UST supply vs risky assets) which they cannot easily resolve because now they are buying both. They could YCC but then they are risking the USD if foreigners decide to bail out of US assets. So, it becomes a trilemma. But that is another story.
There have been two dominant trends in the last four decades. The breakdown of the Bretton Woods Agreement in the early 1970s, the teachings of Milton Friedman, and the policies of Ronald Reagan, eventually ushered in the process of US financialization in the early 1980s. The burst of the Japan bubble in 1990, the Asian and EM financial crises of the mid-1990s, the dotcom bubble, and, finally, China’s entry into WTO in the early 2000s, brought in the era of globalization. This whole period has greatly benefited US, US financial assets and the US Dollar.
An unwind of these two trends of financialization and globalization is likely to have the opposite effect: causing US assets and the US dollar to underperform. From a pure flow perspective, going forward, foreigners are likely to invest less in the US, or may even start selling US assets outright. They are such a large player that their actions are bound to have a big effect on prices.
Foreigners have played an increasingly bigger role in US financial markets. In terms of ownership of US financial assets, if they were an ‘entity’ on its own, they would be the second largest holder of US financial assets in the US, after US households.
Foreigners owned about 2% of all US financial assets between 1945 and the 1980s. That number doubled between 1980 and 1990 and then tripled between 1990 and 2019!
As of the end of 2019, there were a total of $271Tn US financial assets by market value. Non-financial entities owned the majority, $129Tn, followed by the financial sector, $108Tn, and foreigners $34Tn.
The financial crisis of 2008 ushered in a period of financial banking regulation (on the back of the US authorities’ bail-out), which has slowly started to dismantle some of the structures built in the previous period starting in the 1980s. The Covid-19 pandemic and the resulting government bailout of the whole US financial industry, this time, are likely to intensify this regulation and spread it more broadly across all financial entities. As a result of that, there have been already calls to rethink the concept of shareholders primacy which had been a bedrock of US capitalism since the 1980s.
In addition, the withdrawal of the UK from the EU in 2016, followed shortly by the start of a withdrawal of the US from global affairs with the election of Donald Trump, ushered in the beginning of the process of de-globalization. The US-China trade war gave a green light for many companies to start shifting global supply chains away from China. The Covid-19 pandemic intensified this process, but instead of seeking a new and more appropriate location, companies are now reconsidering whether it might make sense to onshore everything.
What we are seeing is the winding down of these two dominant trends of the last 40 years: financialization and globalization. The effects globally will be profound, but I believe US financial assets are the most at risk given that they benefited the most in the previous status quo.
De-financialization is likely to reduce shareholder pay-outs (both buybacks and dividends) which have been at the core of US equities returns over the years. The authorities are also likely to start looking into corporate tax havens as a source of government cash drain in light of ever-increasing deficits. As a result, and as I have written before, I expect US equities to have negative returns (as of end of 2019*) for the next 5 years at least.
De-globalization is likely to reduce the flow of US dollars globally. Foreigners will have fewer USD outright to invest in US assets. Those, which are in need to repay USD debt, may have to sell US assets to generate the USDs. Indeed, the USD may strengthen at first but as US assets start to under-perform, the selling by foreigners will gather speed causing both asset prices as well as the USD to weaken further.
For example, foreigners are the third largest player in US equities, owning more than $8Tn as of the end of 2019. See below table for some of the largest holders.
As a percentage of market value, foreigners’ holdings peaked in 2014, but they are still almost double the level of the early 1990s and more than triple the level of the early 1980s. Last year, foreigners sold the most equities ever. Incidentally, HHs which have been a consistent seller of equities in the past, but especially since 2008, bought the most ever. Pension Funds and Mutual Funds, though, continued selling.
Foreigners are the largest holder of US corporate bonds, owning almost $4Tn as of end of 2019, more than ¼ of the market.
As a percentage of market value, foreigners’ holdings peaked in 2017, but they are still more than double the level of the early 1990s and 8x the level of the early 1980s.
Foreigners are also the largest holders of USTs, owning almost $6.7Tn as of end of 2019, more than 40% of the overall market.
As a percentage of market value, foreigners’ holdings peaked in 2008, at 57%! At today’s level, they are still about double the levels of the early 1990s and early 1980s.
There is a big risk in all these markets if the trends of the last four decades start reversing. US authorities are very much aware of the large influence foreigners have in US markets. The Fed’s swap and repo lines are not extended abroad just for ‘charity’, but primarily to ‘protect’ US markets from forced foreign selling in case they cannot roll their USD funding.
The UST Treasury market seems to be the most at risk here given the mountain of supply coming this and next year (multiple times larger than the previous record supply in 2008 – but foreigners back then were on a buying spree). The risk is not that there won’t be buyers, eventually, of USTs as US private sector is running a surplus plus the Fed is buying by the boatload, but that the primary auctions may not run as smoothly.
It was for this reason, I believe, that the authorities exempted USTs from the SLR for large US banks at the beginning of April. If that were not done, PDs might have been totally overwhelmed at primary auctions given the increased supply size, the fact that the Fed can’t bid and if foreigners start take up less. It is not clear, still, even with the relaxed regulation, how the primary auctions will go this year. We have to wait and see.
This is my reading of an excellent paper by S&P Global, “Examining Share Repurchasing and the S&P Buyback Indices in the U.S. Market” by Liyu Zeng and Priscilla Luk, March 2020.
Over the past 20 years (up to end of 2019), the S&P 500 Buyback Index had outperformed the S&P 500 in 16 out of 20 years, or about 5.5% per year. YTD, it has underperformed, though, by about 14%! With that it, has managed to erase the last 10 years of outperformance!
We had similar underperformance of the buyback index in the early stages of the last financial crisis, in 2007; while in 2009, the S&P 500 Buyback Index had a significant excess return. Make your own conclusions where we are in this cycle.
Reality is that “buybacks tend to follow the economic cycle with increased or decreased repurchase activities in up or down markets while dividend payouts are normally more stable over time, the S&P 500 Dividend Yield portfolio tends to outperform in down markets, while the S&P 500 Buyback Index may capture more upside momentum during bull markets.“
Almost all of tech, financial sector and consumer discretionary companies engage in share buybacks. Less than 50% of utilities do (but they all pay dividends). As share buybacks tend to congregate in cyclical rather than defensive sectors, the buyback index tends to underperform during recessions (this year).
Since 1997, the total amount of buybacks has exceeded the cash dividends paid by U.S. firms. The proportion of dividend-paying companies decreased to 43% in 2018 from 78% in 1980, while the proportion of companies with share buybacks increased to 53% from 28%.
Compare to other developed markets. Despite an increase of share repurchases in Europe and Asia, as a % of all companies, buybacks still stand at about half that in the US. On the other hand, fewer Canadian companies engaged in share buybacks during that period.
For the S&P 500 Index, over the last 20 years, 2/3 of the total return has come from capital gains and only 1/3 from dividends. Before the mid-1980s, when buybacks became dominant, the opposite was true. Buybacks have been instrumental in driving equity returns since the mid-1980s.
The response from the two most powerful central banks could not have been more different. ECB is innovative, using fine tuning and precision in tiered rates and targeted lending; Fed is still throwing the kitchen sink at the market by flooding the banking system with liquidity.
ECB is also going more direct partially because the banking system there is in shatters, but also because it makes sense regardless. Plus, the ECB is already taking credit risk by buying corporate bonds. Surely, the next step is literally direct credit lending and massively expanding the ECB counterparty list.
Fed is still stuck in the old model of credit transmission, entirely relying on the banking system. That model died in 2008, in fact, even before that, in the early 2000s, as the first Basel rules came into effect and the shadow banking system flourished.
Post 2008 it became much more common for financial institutions, like PE etc. to get in the credit loan business. Needless to say, this carries a big risk given that they don’t have access to Fed’s balance sheet like the banks.
The US banking system is now flooded with liquidity. If the new repo auctions are fully subscribed, this will double banks’ reserve balances and will bring them to the peak post the 2008 crisis. But do banks need that liquidity? It does not seem so: the first $500Bn repo auction yesterday had just $78Bn of demand. But that liquidity from the Fed is there on demand, plus the central banks swaps lines are open, and as of March 12, none has been drawn. And finally, the foreign reverse repos pool balance at the Fed has not shown any unusual activity (no drawdowns). All this is indicating that USD liquidity is at the moment sufficient, if not superfluous, so, it should have a negative effect on USD, given long USD has been a popular position post 2008.
All this liquidity, however, may still do nothing to stocks, as seen by their performance into the close yesterday, because balance sheet constraints prevent banks from channelling that liquidity further into the US economy where it is surely needed. From one hand, the Fed is really pushing on a string when it comes to domestic dollar liquidity, but, on the other, it is providing more than plenty abroad.
Risky assets are still a sell on any bounce, and the USD is probably a sell as well, as the Fed will be forced to keep cutting but it is now running a risk of foreign money exiting long established overweight positions in US assets.