As 2013 ends it is easy to be cheered by capital markets activity this year, especially in the corporate sector. US equities have returned 25% this year, continental European stocks 22%.
Bond markets have been exceptionally busy, with a best-ever high yield market and flashy deals to brighten the landscape like Apple’s $17bn issue in April and Microsoft’s €3.5bn transaction last week.
Everyone knows some of this is froth blown by quantitative easing. No one will ever know how much. But when the Federal Reserve eventually slows down the money presses — and don’t hold your breath for more than token tapering any time soon — we will at least discover how sustainable asset prices are without that help.
Investors can’t wait till then to find out, however. Many want to decide now where to put their cash in 2014, hence the rush of advice from banks and the larger investment houses on how markets will move next year.
Most expect the US to lead the world’s recovery, and advise investors to stay in US equities. Few are curmudgeonly enough to suggest that the US bull run is running out of gas just yet.
But a close look at the recovery shows it is still very fragile. BlackRock analysts point out that about three quarters of US equity returns in 2013 came from multiple expansion – share prices rising faster than earnings. Earnings growth plus dividends was only about 8%.
In continental Europe it was even worse: there was no earnings growth, and dividends returned about 3%.
And earnings are the good part of the US economic story. The unemployment rate has come down, it’s true, but nowhere near fast enough. The number of people actually employed is still 1.5m below 2007’s peak — and since then the working age population has grown by 8.5m.
Low income country
Wages are dire. Middle class Americans’ take-home pay has stagnated for years, even as productivity has risen. The period since 2000 has been worst, as a BlackRock graph shows. The wages share of US corporate value added has fallen from 66% to 57%, while the corporate profit share has soared almost to 12%.
Many investors love this. “Companies did a tremendous job … tremendous work on costs,” one crowed recently. Bondholders, like shareholders, are very happy with a fat-margined corporate sector.
But maybe investors should think again. The Beveridge curve, which maps job vacancy rates on to the unemployment rate, has shifted upwards in the past three years. That means for a given unemployment rate, there are now more empty jobs in the US than during the 2005-2009 period.
Perhaps the US lacks enough suitably skilled employees, or perhaps these vacancies pay too little to attract any sort of worker at all.
QE is another policy that helps the rich, by inflating the value of securities and arguably property, while only having a muted effect on job creation or consumer spending.
When companies are holding down wages — and BlackRock expects this grip to get even tighter — no wonder the recovery is producing too little consumer spending, too few jobs and even, too little earnings growth.
What it is producing plenty of is cash — often hoarded offshore where redistributive Washington can’t tax it. Apple, Microsoft and others have so much cash that activist investors have forced them to splash out lots of it to shareholders through dividends and buybacks.
That looks great in the capital markets league tables. US companies can use megabond issues to finance buybacks without repatriating cash. It’s great for asset managers’ return figures, for the portfolios of wealthy investors, and for the share options of executives.
But cash piles stored offshore or shelled out to shareholders are not being invested in new products or new markets by the brightest minds within USA Inc. Nor are they finding their way into the pockets of American workers or consumers. So they are not helping the recovery much.
Investors agree: current US equity valuations are predicated on decent earnings growth, perhaps 10%, coming through in 2014. If companies are wise, they will realise that kind of growth cannot go on forever if the wages share is not allowed to rise again — after all, domestic demand will hardly spike with less money to spend. That could mean lower profit margins for USA Inc.
