History suggests the initial reaction by investors after a U.S. election isn’t always the right one
How could so many asset classes be wrong?
Actually, quite easily. The danger is that investors are responding to their own prejudices, then receiving reinforcement from one another. While the market is internally consistent, that isn’t enough if it has misjudged the big picture—as it often does on the economy, and even more so on presidents.
.. Take the 2013 taper tantrum, or a period in 2010 when markets bet big on a rapid postrecession recovery—only for panic to set in when the economy proved weak.
.. But history suggests markets aren’t that good at judging presidents. And that presidents just aren’t that important to stock prices. The worst performance of U.S. stocks between Election Day and Inauguration Day came ahead of Franklin Roosevelt, Richard Nixon and Barack Obama’s first terms and Lyndon Johnson’s 1964 election, according to calculations by Birinyi Associates. Yet after FDR and Mr. Obama took office, the market boomed, while it did perfectly well under Nixon and LBJ.
The market wildly misjudged the potential of Herbert Hoover. His election-to-inauguration stock price jump hasn’t been bettered, but the 1929 crash was on his watch and no president since has overseen such poor returns.
What the Markets Can, and Can’t Tell Us about a Trump Presidency
Politico reported that Treasury and Federal Reserve officials were monitoring the situation closely, prepared to take extraordinary action, if needed, to save the U.S. economy from free fall.
.. Pharmaceutical companies and private prisons saw their values rise, presumably rooted in a belief that President Trump will abandon efforts to rein them in. Gun stocks fell—a sign that Americans no longer fear a gun-control advocate in the White House.
.. Or, as John Maynard Keynes wrote, “We devote our intelligences to anticipating what average opinion expects the average opinion to be. And there are some, I believe, who practice the fourth, fifth and higher degrees.”
.. Trump has attacked every one of these foundations. How much should you pay for Apple stock, say, if we have to worry about the dollar plummeting in value and the President declaring a trade war on China, which is both Apple’s chief supplier and its fastest-growing market? There is no financial model, right now, for that many levels of structural uncertainty.
.. Markets are designed to make relatively minor adjustments on a fundamentally sound base. They never perform well when the base itself is under assault, as it was during the financial crisis of 2008.
.. Donald Trump’s proposed policies are, in this technical sense, toxic.
.. The repeal of Obamacare, alone, would force many people to forgo their riskier, entrepreneurial ambitions for the safety of a job with a health plan. Curtailing immigration will redirect the world’s most ambitious citizens elsewhere. A trade war with Mexico and China would be damaging in ways that are hard to fathom or measure. Trump’s tax plan will turn America’s serious but manageable debt burden into a crisis weighing on future generations.
Harvard Business Review: Profits Without Prosperity
Consider the 449 companies in the S&P 500 index that were publicly listed from 2003 through 2012. During that period those companies used 54% of their earnings—a total of $2.4 trillion—to buy back their own stock, almost all through purchases on the open market. Dividends absorbed an additional 37% of their earnings. That left very little for investments in productive capabilities or higher incomes for employees.
.. Why are such massive resources being devoted to stock repurchases? Corporate executives give several reasons, which I will discuss later. But none of them has close to the explanatory power of this simple truth: Stock-based instruments make up the majority of their pay, and in the short term buybacks drive up stock prices.
In 2012 the 500 highest-paid executives named in proxy statements of U.S. public companies received, on average, $30.3 million each; 42% of their compensation came from stock options and 41% from stock awards. By increasing the demand for a company’s shares, open-market buybacks automatically lift its stock price, even if only temporarily, and can enable the company to hit quarterly earnings per share (EPS) targets.
.. Even when adjusted for inflation, the compensation of top U.S. executives has doubled or tripled since the first half of the 1990s, when it was already widely viewed as excessive.
.. From the end of World War II until the late 1970s, a retain-and-reinvest approach
.. in the late 1970s, giving way to a downsize-and-distribute regime
.. Since the late 1980s, the largest component of the income of the top 0.1% has been compensation, driven by stock-based pay.
.. A turning point was the wave of hostile takeovers that swept the country in the 1980s. Corporate raiders often claimed that the complacent leaders of the targeted companies were failing to maximize returns to shareholders. That criticism prompted boards of directors to try to align the interests of management and shareholders by making stock-based pay a much bigger component of executive compensation.
.. The result: Trillions of dollars that could have been spent on innovation and job creation in the U.S. economy over the past three decades have instead been used to buy back shares for what is effectively stock-price manipulation.
.. There are two major types: tender offers and open-market repurchases.
.. Tender offers can be a way for executives who have substantial ownership stakes and care about a company’s long-term competitiveness to take advantage of a low stock price and concentrate ownership in their own hands. This can, among other things, free them from Wall Street’s pressure to maximize short-term profits.
.. Exxon Mobil, by far the biggest stock repurchaser from 2003 to 2012, can buy back about $300 million worth of shares a day, and Apple up to $1.5 billion a day. In essence, Rule 10b-18 legalized stock market manipulation through open-market repurchases.
.. the reality is that over the past two decades major U.S. companies have tended to do buybacks in bull markets and cut back on them, often sharply, in bear markets.
.. companies that do buybacks never resell the shares at higher prices.
.. when a company buys back shares at what turn out to be high prices, it eventually reduces the value of the stock held by continuing shareholders.
.. Warren Buffett wrote in his 1999 letter to Berkshire Hathaway shareholders. “Buying dollar bills for $1.10 is not good business for those who stick around.”
.. A related issue is the notion that the CEO’s main obligation is to shareholders. It’s based on a misconception of the shareholders’ role in the modern corporation.
.. As risk bearers, taxpayers, whose dollars support business enterprises, and workers, whose efforts generate productivity improvements, have claims on profits that are at least as strong as the shareholders’.
The only money that Apple ever raised from public shareholders was $97 million at its IPO in 1980. Yet in recent years, hedge fund activists such as David Einhorn and Carl Icahn—who played absolutely no role in the company’s success over the decades—have purchased large amounts of Apple stock and then pressured the company to announce some of the largest buyback programs in history.
.. MSV as commonly understood is a theory of value extraction, not value creation.
.. Consider the 10 largest repurchasers, which spent a combined $859 billion on buybacks, an amount equal to 68% of their combined net income, from 2003 through 2012.
.. Yet since 2003 only three of the 10 largest repurchasers—Exxon Mobil, IBM, and Procter & Gamble—have outperformed the S&P 500 Index.
.. For example, during that period the amount of stock taken out of the market has exceeded the amount issued in almost every year; from 2004 through 2013 this net withdrawal averaged $316 billion a year. In aggregate, the stock market is not functioning as a source of funds for corporate investment.
.. large companies tend to use the same set of consultants to benchmark executive compensation, and that each consultant recommends that the client pay its CEO well above average.
As a result, compensation inevitably ratchets up over time. The studies also show that even declines in stock price increase executive pay: When a company’s stock price falls, the board stuffs even more options and stock awards into top executives’ packages, claiming that it must ensure that they won’t jump ship
.. The vast majority of shareholders are simply investors in outstanding shares who can easily sell their stock when they want to lock in gains or minimize losses. As I argued earlier, the people who truly invest in the productive capabilities of corporations are taxpayers and workers.
.. Exxon Mobil, while receiving about $600 million a year in U.S. government subsidies for oil exploration (according to the Center for American Progress), spends about $21 billion a year on buybacks. It spends virtually no money on alternative energy research.
.. from 2003 through 2012, Pfizer funneled an amount equal to 71% of its profits into buybacks, and an amount equal to 75% of its profits into dividends.
.. If Americans want an economy in which corporate profits result in shared prosperity, the buyback and executive compensation binges will have to end. As with any addiction, there will be withdrawal pains.
Bull Market Blues
there are three big points of slippage between stock prices and the success of the economy in general. First, stock prices reflect profits, not overall incomes. Second, they also reflect the availability of other investment opportunities — or the lack thereof. Finally, the relationship between stock prices and real investment that expands the economy’s capacity has gotten very tenuous.
On the first point: We measure the economy’s success by the extent to which it generates rising incomes for the population. But stocks don’t reflect incomes in general; they only reflect the part of income that shows up as profits.
.. On the second point: When investors buy stocks, they’re buying a share of future profits. What that’s worth to them depends on what other options they have for converting money today into income tomorrow. And these days those options are pretty poor, with interest rates on long-term government bonds not only very low by historical standards but zero or negative once you adjust for inflation.
.. how can profits be so high? The answer, I’d suggest, is that these days profits often seem to bear little relationship to investment in new capacity. Instead, profits come from some kind of market power — brand position, the advantages of an established network, or good old-fashioned monopoly.
.. while record stock prices do put the lie to claims that the Obama administration has been anti-business, they’re not evidence of a healthy economy.