Was corporate profit growth a bubble inflated by "financial engineering"?
openpolitics.comYes. Aggregate corporate profits have not gone up at all: https://fred.stlouisfed.org/series/A053RC1Q027SBEA
There's a long way to go down to normalize this situation. I'm not saying this will happen, but the downside potential is enormous.
Also, don't forget about the 50% of US GDP ($11T) that have been loaded into US capital markets (both debt and equity) by foreigners. This is also hugely out of balance: https://fred.stlouisfed.org/series/IIPUSNETIQ
I thought the same, and had to ask some friends to provide another point of view:
If a company like amazon generates very little corporate profit, is that unproductive growth? Aggregate corporate profits are not the only stat that matters when discussing economic growth/value.
> If a company like amazon generates very little corporate profit, is that unproductive growth?
Of course not. There would be more employees, more taxes paid, more buildings being built, more assets, etc. thus more money going into the economy.
I've always dreamed that companies should run with zero profit (like the outdoor store co-ops like REI or MEC in Canada). They could price their products so they don't make any "extra" money each year after all expenses and salaries, etc.
I think we'd live in a better world if a company like Apple didn't exist to make ever increasing profits, but existed just to create the products they create.
> They could price their products so they don't make any "extra" money each year
Isn't that precisely what you get from competitive pressure in a free market? Things end up priced barely above production costs.
> I think we'd live in a better world if a company like Apple didn't exist to make ever increasing profits, but existed just to create the products they create.
That would be a nicer world to live, true. Unfortunately, we've created a system in which the primary reason for a company to exist is to make profits - and then we pit companies against each other to minimize profits made. The end result is a lot of creativity unleashed in the process of innovating, cheating and defrauding your way into not being a commodity.
> 't that precisely what you get from competitive pressure in a free market? Things end up priced barely above production costs.
Evidently no. Companies are making hundreds of millions in profit every ear, they're paying their CEOs tens of millions as a "bonus".
They're they're making a lot, LOT more than just "barely above production costs"
We don't actually have a free market, though. Free markets don't exist in the real world, only the "perfectly spherical cow in a frictionless vacuum" world of economic models.
There is no competitive pressure within a company. CEO pay is usually an insignificant fraction of a company's revenue; there's enough inefficiencies both within the system and within the market to allow this to exist, even if the actual product of a company is a commodity.
The other part of my comment also mentioned that companies do everything they can to avoid being commoditized: that's another source of inefficiency/surplus revenue. The market is in flux; commoditizing takes time.
"CEO pay is usually an insignificant fraction of a company's revenue" What is insignificant? For example, the CEO of Aetna walked away with 500million. That's money that should have gone to insured, injured and sick people. What risk did he take that exceeded the risks of the children we sent to Afghanistan and Iraq?
Well, according to [0], Aetna's revenue in Q3 2018 was $15.5 billion - so, extrapolating, their yearly revenue was something on the order of 60 billion dollars, of which that 500 million you mention is just 0.8%. Also, some of that $500M is in stock, not cash.
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https://www.modernhealthcare.com/article/20181030/NEWS/18103...
> that 500 million you mention is just 0.8%.
It's not about what percentage of their revenue it is, it's about how that money that should go to adding customer value, not making exceedingly rich people richer.
500 million dollars could change the lives of tens of thousands of people that Aetna calls customers... but instead it goes to ONE person.
It doesn't have to be that way.
It also says that the net income is 1 billion though, and 500 million is half of that. High revenue doesn't always mean that the company is generating that much value. Just look at Uber.
I really dislike seeing comments like this on HN, just utter lack of foresight into just the basics of economics or even just commenting. What "companies" are you talking about? What does CEO pay have to do with the subject at hand?
I'm genuinely asking questions about why the economy and setup is the way it is, and why can't we change it to something better.
Everything can be improved, and we should strive to improve everything. I'm very aware of companies that operate very well without making a profit. They add a lot of value to society, the employees get paid and they're even expanding (MEC in Canada). But no profit. Nobody who doesn't work there gets richer. So why don't Apple work that way. Why doesn't Comcast work that way.
CEO pay represents a huge surplus of money (profit) that wasn't needed. The products and services offered by the company could have just been discounted that much, or the employees could all have been paid more, not just one person.
Please search Google salaries on papers regarding executive compensation. The pay they are receiving is usually economically sound and integral for the whole system working.
It's very hard defend the argument "CEO pay represents a huge surplus".
How much value does that CEO being by his skills/decisions? Why would he be hired with the salary he receives (that he does not get to decide) if he didn't create more value than what he costs? It's just like any other employee, except a more competitive space and where decisions have larger profit effects.
The postal service kinda works like that. It can make some profit in some countries but not much. In the US Amazon accounts for 40% of the parcels. Putting things into boxes and shooting some web is impressive but getting the boxes from A to B also takes some doing.
Dreaming that other people would gift money to other people (including you) is not a sound economics theory.
You are against join stock companies, but not interest bearing loans/bonds or arbitrarily high salaries for managers? Why?
This is what the government is. It's a large non-profit, in fact the largest player in the economy, that's always zipped to produce no profits. There isn't even any structure to distribute the profits (there are no "shares" of the government or anything of this sort).
The whole point of profits and investing is to hook up the "skin in the game" of investors to viability of project. That's the definition of capitalism.
> That's the definition of capitalism
It's interesting though that there are certainly extremely successful companies like MEC in Canada and REI in the US who don't follow this model.
Their customers are extremely happy. Their staff get paid. The y create excellent value for customers. BUT they don't make a profit. Nobody can get rich from owning a slice of it.
Why couldn't more companies be like that?
Amazon is truly exceptional, do not make a rule out of it. Bezos is kinda like Buffett, in their own league of master capital allocators. For example, Amazon got a lot of financial leverage on the "float" between credit card payments and sending the money to merchants. Again, kind of similar to Berkshire which is leveraged on the insurance "float".
Also, heavy CAPEX or any other form of internal reinvestment does not mean there should be no profits. Look at Google, Facebook, Apple, Microsoft - all those companies were bootsrapped mostly through internal cash flow. All of those companies were profitable when IPOing (just look at historic S-1s).
Heavy CAPEX doesn't require no profits, but it can easily result in that.
If, over the long term, CAPEX spendings do not produce profits, it means that the purchased assets did not produce enough payoff to compensate for their depreciation charges. You could argue with the accounting depreciation rules (i.e. how much needs to be written off per year, i.e. you think the asset is longer lived than the accounting rules say), but the general idea stands - it is a sign of bad capital allocation.
If the profits from the CAPEX just get plowed into more CAPEX, though, you could end up looking like you don't have profits for decades, and it isn't necessarily a problem as long as you're growing.
Edit: What I'm saying is that profit is a lagging indicator of CAPEX, and your lack of profit now could be the result of bad CAPEX 5 years ago, or good CAPEX 5 years ago, plus aggressive new CAPEX now.
I think you don't know what "profits" are, i.e. don't know accounting.
CAPEX is written down via depreciation charges over many years. I.e. if you buy something for $1M, and it has an accounting life of 10 years, you book $100k losses per year.
What you're thinking about is called "cash flow", not "profits".
Is this not basically what Amazon did? Massive capital expenditures with cascading depreciation that wiped out profits while increasing cash flow until they got to a certain size and decreased CAPEX and recognized profits?
>>If, over the long term, CAPEX spendings do not produce profits, it means that the purchased assets did not produce enough payoff to compensate for their depreciation charges.
Even if CAPEX generates profits, if the returns were lower than your capital cost then company would have been better off not investing and returning that instead to shareholders.
Yes, that's the 101 of being a capital allocator, like a CEO or a CFO. Only invest into anything if the returns exceed your cost of capital.
Presentation on this very topic: https://youtu.be/c20_S-QgvsA?t=730
Shareholders would be better off, not company better off. Wage earners in the company got paid.
It is not "unproductive" from the perspective of the economy, but it is "unproductive" (i.e. low-returning) from the perspective of shareholders. We would not expect to see share prices rising if corporate profits in aggregate are not rising (unless there is some financial engineering going on).
We would expect it under certain circumstances. One explanation could be falling interest rates. Lower rates on bonds incentivize investors to take on more risk (moving more money into equities) in order to still meet their return targets.
Or more directly into valuations: govt bond yields are a component of equity discount rates (discount rate = risk free rate + equity risk premium). Of course low bond yields should also mean a slow economy, and thus lower future cash flows. After all the risk free rate is approximately the nominal GDP growth. So I'm not sure how far should this argument go ...
Another is share buybacks (which I think are entirely fine).
Same amount of profits (DCF + discounted terminal value) spread over fewer shares implies a higher share price.
Not fine if the execs get paid bonuses measured in a certain number future shares.
I guess this would count as financial engineering though.
This is a good point. I agree.
It wont, they just showed that they rather let the system explode than implode; the balance, proper self-organization, invisible hand etc, was lost ten years ago
History has plenty examples of bailouts. “Invisible hand” was never there to begin with, much less 10 years ago.
Sure. The point is that a gardener can not force plants to grow, neither can he create them by himself; only assist in the proper conditions for growth. There is such a thing as too much water and fertilizer which is more problematic than none at all
Sadly, I believe you're right, and this scares the shit out of me. To put it bluntly - we will not have capitalism any more. Capitalism must provision for and handle failures, and this is not currently allowed to happen.
The real question is: was it ever allowed to happen? There have been bailouts in some form since forever, it seems.
can you provide a list of examples?
Everything the Fed, the BOJ, the ECB, the SNB and what have you are doing, reducing all the rates that they can:
Also China, but China is special, and has a much more fine grip on things that goes far beyond the general rates (they can target sectors specifically, or even individual companies).- starting from short riskfree rates [all since 1981, but problems surfaced only in 2008] - to long riskfree rates [all since 2008] - to corporate default rates [ECB since 2012, the Fed since 2020] - and in some cases, even to equity risk premium rates [BOJ and SNB since 2008]Expect more alphabet soup of pump facilities to materialize. I don't bother listing them here, it's all the same (reduce this or that rate).
Yes, but it all started in 2008 (to me, the starting point was really the 1998 government bailout of a private business - a hedge fund LTCM [1]). It was all downhill from there.
Still, not "since forever", only since 1998, or so.
1. https://en.wikipedia.org/wiki/Long-Term_Capital_Management
the example I was directly thinking of was Italy's IRI from 1933[0] which was a conglomerate directly aimed at restructuring failing public companies through nationalization, it kept doing it for decades. AFAIK other countries had similar national behemoths.
The US set up the Home Owners' Loan Corporation[1] during the great depression to refinance loans saving a lot of banks from disaster (tho helping common folks too), and there were also the savings and loan bailout in the '80s and '90s[2]. Chrysler was bailed out in 1979[3] and Lockheed in 1971.
[0] https://en.wikipedia.org/wiki/Istituto_per_la_Ricostruzione_...
[1] https://en.wikipedia.org/wiki/Home_Owners'_Loan_Corporation
[2] https://en.wikipedia.org/wiki/Savings_and_loan_crisis
[3] https://www.investopedia.com/articles/economics/chrysler-bai...
If we assume that corporate value is relatively unchanged from 2014 and then assume that the government bails out the companies by paying off the debt, then the stock market's growth from 2014 would be a form of inflation, wouldn't it?
Yes, asset inflation. Which we've seen (in corporate & startup valuations). We have not seen similar inflation of goods in the wider economy (except real estate, health care and higher education).
>(except real estate, health care and higher education).
All also being assets. (Health care equating to health). Who has benefited the most from asset inflation? Those well off or the lower working class?
Real-estate is assets, of course.
But I think the inflation in health-care/education is caused by lack of competition.
As in - you can choose to not buy a new coat this winter, but you HAVE to buy health insurance. You HAVE to buy college education for your kid or otherwise s/he won't be able to ever start a family (working as a barista, or some such).
Also, none of these services were outsourced to cheaper location (because they can't. although a good number of people have been going abroad to get their medical degree, etc.)
Not only inflation. Certainly earnings increased in many cases due to tax cuts and tax forgiveness, such as allowing US tech companies to repatriate money at reduced tax rates. If you assume the tax cuts will continue, the stocks are more valuable.
Profits don't (really) matter. If your revenue is growing 100% YOY, and your profit is -10%, who cares? If your costs aren't growing as fast as your revenue, then it's easy to turn a profit if you choose. Companies choose not to because it hurts them long-term. They choose to grow and enter new markets as fast as possible to get a foothold.
Growth only matters to the degree that it will eventually lead to higher dividends though, from the perspective of shareholders. At some point companies (or the companies that acquire them) need to yield a dividend or else it's all a Ponzi scheme.
Yep, and some stocks are priced for a date decades away.
> If your costs aren't growing as fast as your revenue, then it's easy to turn a profit if you choose.
Doesn't that make a lot of assumptions about assets, expenditures, and business model?
If I start a business handing out $0.99 to anyone that gives me $0.90, I think I could easily grow revenue at a 10% loss for as long as investors were willing to fund it.
If your business is selling $0.99 for $0.90, then its costs are growing FASTER than its revenue. You are describing UBER vs. someone like AMZN.
If your revenue grows 100% YoY and the profit keeps declining, your costs ARE growing as fast, as your revenue.
Are blue chips like Coca-Cola entering new markets so much?
People who invest in Coca-Cola are interested in dividend growth. People who invest in Amazon, Apple, Google, MSFT are interested in them entering new markets.
Profits do not need to go up for the value of a business to go up.
It's certainly more nuanced than that. However, it does point out the fact that corporations focus too much on shareholder value as opposed to just making a good business system...except for the major players that is.
These the so called "too big to fail" types of companies which borderline monopolize market sectors like Amazon and Walmart. But they don't care during recessions because they're fine. They essentially are the government as they have a larger impact on your daily life than the actual government!
It's not so much that the stock buybacks are the straw that broke the camel's back, it's just another inevitable economic event that the invisible hand dealt. There is no stopping it. Otherwise we're just back in a labor economy again where money can't flow where irrational people deem they need to place it.
It’s not the “corporations” as this abstract entity that are focusing on shareholder value as a top priority.
It’s the C Suite members, and it’s the board members... it’s a small group of people at the top who are trying to enrich themselves at the expense of the company and at the expense of the people who actually run the company.
Yes that is most definitely true. The intent isn't for your company to go spiraling down into bankruptcy. The problem is these bourgeoisie types at the top don't change even after getting bailout money. Why the hell are we rewarding the people who maintain a company culture of "Well if we go bankrupt, we'll just ask the government for money cause they can't afford for us to go out of business!"
It's a load of crap that this is even a concept if the government cannot get involved at that point.
under the guise of enriching the company through stock growth
> They essentially are the government as they have a larger impact on your daily life than the actual government!
Amazon and Wal Mart could disappear overnight and I would just shop elsewhere. Amazon isn't in charge of my water quality or road maintenance.
Are you sure about that? All the people in your town would also have to shop at those alternatives as well.
Do you think that there is enough inventory and stock to go around? Would those alternatives replenish their inventory in a timely fashion? Would you seek alternatives to your normal shopping?
I think people vastly overestimate the capabilities of their local options.
People also vastly underestimate how hard it is to produce commodities. Like, if Amazon disappeared overnight then we'd just all switch to something else and no issues would arise. What nuttiness!
> People also vastly underestimate how hard it is to produce commodities.
Neither Amazon nor Walmart produce those commodities, they distribute them. Sure, there would be some initial issues, but both the remaining distributors as well as the producers would have strong incentives to quickly resolve those issues.
Obviously there would be temporary shortages in some areas heavily dependent on Wal Mart, but elsewhere where Wal Mart is one of 20 similar stores, the surrounding businesses would be able to handle increased business. That one Wal Mart suddenly closed to prevent union forming and the town survived. Brick and mortar in general would have growing pains but also adapt.
So people didn't buy things before Amazon?
Of course they did—the same way they bought things at the local mom & pop stores before Walmart came in, undercut them, and drove them all out of business.
Companies like Amazon and Walmart massively distort the market, and do so quite deliberately. It's hopelessly naïve to think that if they vanished tomorrow, everyone would be able to just shrug and switch their purchasing to a drop-in replacement.
That's only possible in, as someone else described it, the "spherical cow in a vacuum" type of hypothetical free market. We live in the real world, where an arbitrary number of fully equivalent businesses can't actually continue to compete perfectly for everyone's money.
Depends where you live. In Cleveland, there's still plenty of small shops I go to all the time. I also order from Amazon and shop at Walmart.
Keep in mind that over the past couple of decades, Walmart has replaced small mom-and-shops in most towns and small cities.
An enormous amount of people in America would be utterly screwed if it went away.
For a few weeks possibly, but most of their items can be ordered online and their failure would open many doors for new stores.
Also, the overwhelming majority of people are driving to Walmart so even if significantly less convenient they can also drive somewhere else.
It would open many doors over the course of a few decades of market correction. Just cause walmart closes shop doesn't mean local poor people suddenly have the capital to start a business and compete. It's why ghost towns are still a thing. When the oil derrick town dries up, the driller who now lost his job isn't gonna just start drilling for oil now.
Sounds like a decent reason to nationalize Walmart (other than that their margins are very thin and it’s unlikely anyone could do better)
Why nationalize them? What would be the point? The purpose for nationalization is to give preferential treatment to the state. Walmart already does that and (in my personal opinion) does for the people as well.
Although the only thing I wish they cut back on was their employee culture cult stuff. It reminds me of McDonalds where you have to say thank you to a supervisor after everything, even if they're yelling at you to be a dick. It's like the f'ing military. That kinda brainwashing garbage needs to go.
> These the so called "too big to fail" types of companies > which borderline monopolize market sectors like Amazon and Walmart.
It's somewhat interesting that when coming up with a list of two 'monopolist' companies, you came up with two companies that compete directly.
They monopolize supply chains. Not a specific market. Walmart has a reputation for exploiting companies to solely work for them because the money is too good. Then they force them to make it at insignificant margins until they can't anymore. Amazon as well.
>Otherwise we're just back in a labor economy again where money can't flow where irrational people deem they need to place it.
I find it interesting how in economics, analysis is based on rational actors, but whenever something goes wrong or doesn't agree, it's irrationality's fault.
Maybe there is a rationality to perceived irrationality that simply doesn't agree with the sensibilities of the claimer of other's initial irrationality?
> They essentially are the government as they have a larger impact on your daily life than the actual government!
Even if that were true, "the organization that has the biggest impact on your daily lives" is a weird definition of "government".
Just to further highlight the lunacy of that definition, most people's "government" is their employer if you define government in that manner.
Your employer most certainly "governs" your life in ways you may not even be conscious of. Just because they don't have a label on it in that way doesn't mean the concept doesn't exist. Industrial feudalism is the same as the old ways, it just confuses people more because there are innumerable things to do, buy, and see. You're "employer" is no different than a fief. The "entity" is the manor. The "inheritance" is described in the companies by-laws. And yes, it is 100% legal to have direct inheritance to your kin, and you can even write it in the by-laws that cannot be usurped by the board. You can write whatever the hell you want so long as it doesn't go against the way the federal government wants you to play the game (IE, basically the Emperor of the HRE or Emperor of China proclaiming a mandate for all tributaries to follow).
Your behavior is shaped by so many external influences that we often forget that the government most often has very little direct influence in our lives. Businesses typically encounter more interactions with the government, but average folks interact with businesses. Corporate cultures in a weird way end up becoming our "culture" we believe in, our "religious" views (not in a theological way). While we're all essentially considered "Freemen" in this world, sometimes you are not because of things like bills or debt bondage. You cannot leave from your "Lord" or "company" because you owe a debt somewhere or simply cannot afford to leave. It's a complicated system, but the concept of fuedalism has just been expanded.
The first point I make is that profit growth has been flat since ~2014 but the stock market has gone up quite a bit.
My question is: Why had the stock market continued to go up despite flat profits?
My guess is that the answer to that is cheap debt from the fed keeping interest rates so low for so long. The stocks had value beyond what you'd expect from P/E ratiosand assets alone because there was added future value in the form of anticipated stock buy backs.
If debt is that cheap it would be irresponsible to finance the firm with equity.
That really depends on your timelines and risk tolerance assessment including externalities.
To use poker as an analogy: if you aren't sufficiently bankrolled, the correct play (most positive EV) can involve an unacceptably high risk of ruin. ....and BTW are you also factoring in the probability of fraud or a government seizure in your calculations?
> If debt is that cheap it would be irresponsible to finance the firm with equity.
Why?
'flat' only if you see through the shenanigans; otherwise, EPS (earnings per share) have increased, by reducing the outstanding shares.
When interest rates are low, firms can finance to buy back. Not only that, investors shift their investments to stocks, instead of bonds. Two forces are at work to pump stocks, both forces are products of low interest rates.
When you say profit growth was flat, that means that profit grew linearly, correct?
If true then that's pretty impressive and possibly much better than what the markets ~10 years ago expected?
Sorry, to clarify, their profit hasn't been growing.
Since 2014, Profit (before taxes) has been roughly $2.2 trillion every year.
Ah right. Good point then!
I agree. I think one of the more interesting approaches to solve this particular problem as well as private companies staying private too long is the Long Term Stock Exchange. I don't know a lot about it but from my understanding, it aims to eliminate short term investors which removes a lot of the speculative nature of public stocks. Not sure that this would eliminate stock buybacks but the long-term investors might be more interested in traditional dividends.
It also likely eliminates all but the quite wealthy from investing in one of the greatest wealth-creation engines of the modern era.
Playing with stocks is no different than selling phsyical commodities, except that unlike selling items on amazon, ebay, craigslist, or your own storefront, you have NO idea what that share will be worth. Plus even a 20% return on 10 shares of say amazon will give you a decent amount of money, all you are doing is sitting waiting to sell. It's not even compounding of an increase. So you need an incredible amount of capital and knowledge of the market to even make it worth your time, much of which most people don't have. It's very easy to lose money in the stock market. It's completely nonsensical to believe that everybody is competent enough to play into that system. Most people understand how to directly translate their labor into a currency. If it was an easy way to get rich, why aren't most people drawing an income off of it? Because they need a job first for their principal. Which tends to often get eaten up elsewhere for a myriad of reasons.
>They essentially are the government as they have a larger impact on your daily life than the actual government!
Amazon and Walmart's power comes from being cheaper/better than the alternatives (though they may engage in unfair and unethical behavior as a means to that end). Government's power comes from having a monopoly on violence. These are very different and one has to be very far removed from government violence to think otherwise.
This is definitionally correct, but frequently far from reality.
Desperate people with no practical negotiating leverage may have the theoretical power of foot-voting, but it provides zero practical value.
Given that a lot of regions outside of urban areas are varying degrees of labor-monopsonies with a very few large employers, not having an official right to shoot your workers really doesn't make a massive difference in the amount of control they can exert.
Do people not expect the market to go down when business revenues have been forced lower due to unforeseen circumstances? The fact is a valuation made in November 2019 had no way of taking this into account.
This isn't to say whether or not it's a bubble, but I am surprised at the number of people who think that stock prices going down is due to financial health of companies rather than people attempting to sell stocks either in a panick or because they suddenly need the liquid cash on hand (due to job loss) and are thus willing to sell at a loss.
And regardless of their merits or demerits, share buybacks do increase actual earnings per share, which is one method to valuate shares. It's like, if there are four partners in a partnership and two decide to buy out the other's shares, their shares are now worth twice as much, assuming the corporation continues making revenue.
Then I hear about corporate debt and how that forces layoffs. The fact is companies are not going to retain employees when they cannot conduct business, regardless of cash on hand. It's not even a moral concern. Companies can simply layoff their employees and have them receive unemployment insurance. Even if they wanted to be 'ethical' and provide health insurance, the cost of a severance package with 18 months of health insurance is less than paying them and providing health insurance. From a corporation's perspective, irrespective of how much cash or debt they have, layoffs are simply superior.
> I am surprised at the number of people who think that stock prices going down is due to financial health of companies
The financial health of many companies is significantly affected by virus mitigation strategies. Companies that were healthy in January may be on the brink of insolvency in June. The market is pricing that in to some extent.
Yes, this is due to the virus, not the previous financial health of the companies. YOu have companies in danger of folding because creditors may be hesitant to give fixed-term loans to a company for which no one can determine a business resumption date. That does not reflect on the pre-virus financial health of the companies. Any company would find trouble with liquidity when its business model has been suspended suddenly and indefinitely.
"It's like, if there are four partners in a partnership and two decide to buy out the other's shares, their shares are now worth twice as much, assuming the corporation continues making revenue." - I don't understand how you calculate that. Let's say there is a company with 4 shareholders with equal shares and with discounted future earnings of $2 million plus $2 million of cash. That makes the company worth $4 million and each share worth $1 million. The company then buys two shares for the $2 million in cash it has. That makes the company worth $2 million (it has no more any cash and the discounted future earnings are worth $2 million) - and the two shares left are each worth $1 million - exactly like before the buy out.
Companies capital reserves often don't count in valuations. It's just the discounted future earnings. Cash sitting in a company's coffers would often count against it, since the rate of return on capital would be lower (larger denominator), and investors are seeking a higher rate of return.
The fact of the matter is, companies should not keep 'emergency cash reserves' enough to operate for six months. The money should be returned to shareholders. Shareholders and other investors should keep liquid cash reserves for emergencies. Then, when companies face emergencies, they should issue new stock to the markets, and the saved up emergency capital can be used. That leaves individual share holders and potential shareholders to decide the fate of companies, which seems more in the spirit of democracy.
You have to factor in expected growth, divvied amongst fewer shares.
> because they suddenly need the liquid cash on hand (due to job loss)
How much market volume do you think is attributed to retail investors?
About 7% on average I believe but I can't know about on non average days, like the past ones have been.
I know a lot of people who logged in to their accounts last Monday who never normally to sell shares and hold cash until the market bottoms. I'm guessing the retail volume in the past week has been higher than ever.
Even barring retail investors telling brokers to sell shares, there are all sorts of reasons consumer behavior can force share sales including increased expectation of withdrawals by banks, people not contributing as much to 401k. Defined allocation mutual funds rebalancing, etc. Also, today a lot of low cost brokerages sell trades to algotraders for fulfillment, so an order for the sale of 1 share of a consumer investor can end up accounting for more in trading volume
Hm, not OP but I'm guessing 5-10% maybe?
The bubble has been enabled by the Federal Reserve. Quantitative easing and money printing has served to inflate asset prices over many years.
For some reason markets going up is fine but when they inevitably decline sharply this is viewed as 'disorderly' and the Fed prints money to keep asset prices high. The Fed ensures that hedge funds have counter-parties to buy their toxic overvalued assets.
It's now clear that our economic system is run for the benefit of corporations and hedge funds.
The Fed also kept interest rates near zero for years after the last recession. That’s where all the cheap credit came from in the first place.
2008 made that blatantly clear.
Everyone always seems to knee-jerk forget that corporations are employers...the economy is run for people. People work for companies. Companies compete, and the financial gymnastics they do to get there is done by people also. Companies are not sentient. (you could argue that they have some meta-sentience, but it is pretty unspecific)
Honestly I've always shared a perspective much like this until yesterday someone mentioned that through the stimulus (I'm not sure of the figures, but what I roughly recall is) each citizen gets $1200 they're then taxed on, and companies get the balance as an interest free loan. If the balance of the stimulus had been simply evenly distributed to individuals, everyone would have received nearly $10,000.
I can't imagine what would happen if you gave every citizen 10k. I would think there would likely be something akin to a revolution that may or may not result in a more robust economy. What the gov't is doing by giving so much money to existing companies that have already failed vs individuals with the possibility of failing is very much protecting the existing social structure of society.
Corporations like these are a hierarchy that generate implicit social striations in our society. By maintaining this regardless of the fundamental success of the product or competence of the management, they act only to preserve the class structure enforced by the institution and thus the stability of society in a configuration with marginal utility as regards productivity.
They're clearly ensuring their own future.
competition == unemployment. corporate failure == unemployment. innovation == unemployment.
Maybe all in the short term, but, this stimulus is specifically looking to avoid short-term discontinuities.
That said, I'm a big fan of corporate stress tests and capital buffers as well. I'm not a fan of debt-fueled share buybacks, but, I understand them as a response to a system that allows them.
do you really think it's likely that they can avoid short term discontinuities in this context? Maybe we should be looking farther ahead?
> each citizen gets $1200 they're then taxed on
The $1200 that people are getting is tax-free.
Jordan Peterson makes a clear point about how the right is for stable hierarchies but they can destabilize and become corrupt, and that's where the left comes in to balance them. Wanting to see the best doctor if you get cancer or seeking out the best construction worker to remodel your kitchen IS a hierarchy and it's a good thing.
I'm not sure I completely understand your comment, but I think hierarchy is a structure that is useful for a society when the exchange of information is naturally constricted. Accreditation, status and authority are strong signals in a setting with limited bandwidth, but when communication becomes more robust.. it's more attainable to construct a heuristic to find utility unique to a specific instance or situation. Aspects of what I think represents the best cancer Dr may not jive with what you think the best cancer Dr is (locality? alternative medicine? cost vs probable outcome?)
Hierarchies are still important, but now they're just training wheels in many instances.
The corporate vehicle is a fantastic invention. The problem is that when fortune 500 companies fail by taking on too much risk (debt, acquisitions, regulatory breaches) they are bailed out. These bailouts prevent their competition from taking their business or competing fairly. Or prevents new companies springing up from their ashes.
Let's keep the party going. My 401k is in tatters...
> It's now clear
only if you haven't been paying attention
This reminds me of a paper I read in the Quantitative Finance section on arXiv.org, in which the author claimed stock markets are being manipulated by big portfolio owners, because the gains happen overnight, while the intraday returns are negative. I'm not endorsing this idea, but I consider it a fun conspiracy theory and maybe it's a good time to throw this into the discussion here.
Even if whatever this paper suggests is true, it won't contribute that much to the inflation of stocks. In this bull run, index funds have performed better than hedge funds. As long as the majority of investors (in terms of their aggregate holds) agree that the price of equities is fair, the ride will continue.
"When a measure becomes a target, it ceases to be a good measure." (Goodhart's law)
Does this apply here? It seems you could argue that profit is the one true number that _is_ a good measure, but it seems even that can be 'hacked' so that it isn't good anymore.
> It seems you could argue that profit is the one true number that _is_ a good measure
A measure of what? As a proxy for social utility, it's been thoroughly gamed and the two have little correlation.
Profit is currently used as a self-serving measure, because you can eat profit (after exchanging it for bread, or drugs, or yachts). In this sense it can't be hacked. Accounting around it can be and is, though.
Money returned to shareholders is the "one true number," even moreso than profit. Retained earnings are only valuable insofar as investors expect them to be returned in the future -- a company that pays no dividends, buys back no shares, cannot be bought out, intends to operate until it goes insolvent, and cannot have a new board brought in to change these policies is "worthless" as an investment vehicle.
So in principle there's nothing wrong with the buybacks. However, investors can have the mistaken impression that these buybacks would continue into the future, and predictions of the future -- and thus the fair stock price -- can change in a heartbeat.
It's a good argument for why companies shouldn't monomaniacally focus on profit, but in practice they don't really seem to do that in the first place. (In fact, one of the prevailing concerns about the recent stock market has been that it focused too little on profit, with many large tech companies trading at extreme multiples of their earnings based on stories about how cool and important they are.)
One man's bubble is another man's under valuation.
Big moves when there is big news (like a global pandemic say) are normal events.
The thing I find concerning is why the FED are "intervening". Dumping cash made sense during a cash shortage. But when there are actual, real, concerns about the future (coronavirus), price falls are perfectly correct. They don't need "fixing". Happy to be corrected if anyone knows?
The idea is similar to the previous financial crisis, except this time, it’s abstracted a layer higher. The previous crisis was a severe drying of credit that had (what they literally called it) a “contagion” and systemic effect. This time, there’s an actual contagious virus that is threatening the banking system if people can’t pay their bills, and the banks can’t pay who they owe because too many borrowers default. In other words, the Fed stepped in proactively because they saw the writing on the wall and wanted to avoid any drying of credit.
The idea was never to keep the economy afloat- it was to build a bridge to prevent being exposed to the rough waters.
I personally think the FED is under political pressure to make the DOW look good because that is tied to certain politicians reelection. Perhaps I read too much bullshit or am too cynical but it seems like they are pushing for good looking but entirely bullshit numbers because a dollar won't be worth what it used to be.
It's happening at some layers above where personal finances occur. There is a massive demand for digital USD (bank liquidity) around the world, this is coming from a few directions such as domestic and international companies taking out new loans and calling in terms of existing loans to keep afloat without having income right now. International banks needing more USD to meet increased demand. It's like a perfect storm of massive hidden types of debt and leverage all came crashing down at once, there are 10x the amount of the stock market in derivatives such as futures and options so when these bets went bad it is causing the ultimate dollar black hole to occur worldwide at the same time.
Thanks, the international side and "flight to safety" hadn't occurred ti me (and I am an international!). That makes more sense.
The fed provides a boost when demand-side goes down; that's one of its roles in emergencies. Their move here didn't make sense since the initial impact was largely supply-side (demand-side drop is coming...). These adjustments were somewhat knee-jerk and somewhat pressure from the public/Whitehouse.
Their moves so far might float us though a short recession, but it's not clear at this point if it will be enough.
You might be right, but this sounds like Austrian School policy thinking after the crash of 1929. That depressions are good in the long run, bankruptcies are fine, the economy will self correct, etc. https://en.wikipedia.org/wiki/Great_Depression#Common_positi...
You can't really deny that ABCT hasn't been accurate in predicting the results of ongoing QE.
I get mainstream econ looks down on it, but given the fact sticking strictly to Keynesian thinking has led to businesses being incentivized to create faulty product (Boeing), committing outright fraud (Wells Fargo), causing widespread destruction through abdication of due diligence (PG&E), exploiting addictive chemicals for business growth and engaging in unscrupulous price gouging (Shkreli, Pharma st al), and our current economic powerhouses are increasingly centered around consumer finacialization (every bloody major tech company), and for God's sake, Juicero happened; I'm honestly curious if the Austrian's might not be on to something.
Maybe the market does need to crash down to the basics. I just don't know if there is really a way for that to happen at this point given how capital is so damn centralized right now.
The problem is I just don't think it would be politically possible in the slightest to actually just sit back and hands off; and even if someone were that bold, they'd basically have just proven that there is no reason for them to exist as an institution anyway.
Which I don't necessarily think is an inconceivable state of affairs, but I don't see the economists of the world throwing in the towel and admitting that willingly.
Is the sky blue? The Pope catholic?
Vast money supply inflation, rock-bottom interest rates, stagnant wages, share buybacks. All accelerating over the last several decades.
Here's what I don't get: this article claims that big (since that's what matters for stock market index levels) business sits on a mountain of debt. At the same time many economists (e.g Yanis Varoufakis) claim that big business sit on mountains of cash kept in tax heavens rather that "working" for the benefit of the economy. Which way is it and are there any confirmed statistics to check it?
Both. Racking up domestic debt using offshore cash as collateral. It's like getting a low interest loan using your 401k.
Ok, thanks. Then the premise of this article is even weaker. Companies do generate huge profits albeit most of the hidden through accounting engineering. It's more likely that the inflated stock prices represent the actual "value".
And a lack of better places to put the money.
How about taxing corporate stock buyback transactions at a high enough rate to make it hurt, and keeping the money set aside for social safety net and training programs that support the people who are losing their jobs.
History has shown again and again that corporate tax cuts and repatriation schemes go right into stock buybacks and don't trickle down nearly enough to individuals. So tired of corporate welfare.
Assets across the board are and were massively inflated because there's tons and tons of money out there any not enough investments for it.
There was an interesting interview with Chamath Palihapitiya on CNBC last week. Whether you like him or not, he made some good points around buy-backs and earnings per share manipulation.
Worth listening to the full interview if you have 15 minutes: https://www.youtube.com/watch?v=NvEWez59fbI
Exactly, the Fed has artificially held rates low so companies are borrowing money for practically 0 to keep the price up and keep CEO compensation high. The only way to really fix the buyback problem is to outlaw stock based compensation for the C-suite and BOD. Then they might start focusing on long term corporate health instead of stock price and short-term quarterly numbers.
Issuing debt to buyback stock isn’t ‘financial engineering’ its trying to address the fundamental problem of corporate finance. You have two sources of capital, debt and equity. What is the optimal capital structure of the firm.
There is no moral component as to whether a firm should be financed with debt or equity. While EPS has a smaller denominator, it also has a smaller numerator as earning will reflect the interest payments on the debt.
For a more balanced view, you can turn to JP Morgan's Guide to the Markets. It's a reliable summary of actual data so you can draw your own conclusions.
https://am.jpmorgan.com/blob-gim/1383407651970/83456/MI-GTM_...
One of my main points is that you need to look beyond earnings per share to see the bigger trend.
What slide/s would you use from the JP Morgan Guide that is better than the St. Louis Fed chart I featured?
The Chart on Page 7 looks fantastic but it is earnings per share, not total profits before taxes.* https://fred.stlouisfed.org/graph/?g=qx3rThe question I would ask is why the stock market graph looks so different than the St. Louis "Corporate profits before tax" graph?
My hypothesis is that many of these companies borrowed a lot of money in the bond market to buy back their shares and thereby juice their earnings per share.
I don't understand the point you're making. Stagnant corporate profits can happen for a lot of good reasons, particularly when there's GDP growth over the same period. Increased labor pay, increased competition, cheaper and higher quality products for consumers, long-term minded growth at the expense of short-term profit taking, etc.
Profit also involves some major accounting nuances. In SAAS, for instance, advertising costs resulting in customer acquisitions are generally accounted for upfront, reducing accounting profits in the period of acquisition. This is opposed to other industries, where investments are more easily capitalized and then charged over their useful life.
This is an excellent deck. Thank you for sharing it!
The amazing thing about bubbles is that you can only know that was a bubble only after it explodes but you can never predict it before.
Before 2008 it was amazing how many people outside of economics, finance, and politics were able to see a disaster coming, but almost everyone in those sectors was completely blindsided.
How many of those people held that same view for 5 years before finally being right?
It’s easy to call a market reversal if you’re comfortable calling 9 of the next 2 reversals.
There's plenty of proof that people in those industries saw it coming. The question was when. Some people in them even thought it would pop years before 2008. If you acted on that then you lost despite being right because you didn't get the time horizon correct.
Ok so we just need those people to write a precise definition of "bubble" so we all can see it coming
In Europe we have this thing called “covered bonds”. In scandinavia Atleast half of the housing loans are packaged into these.
OSAM has a great data-driven analysis of this question and end up on the other side in the conclusion: https://www.osam.com/pdfs/whitepapers/_2_Commentary_Buybacks...
So many problems with this analysis. 1.) main paper cited is from 2006, 2.) article is from 2016 3.) much of the data is older, several plots go to 2014 4.) almost no analysis that looks at long term profile of companies that do this over and over
One use of financial engineering is to distill risk into very narrow products that allow innovative instruments to be created.
The problem is that systemic risk is then distilled out of the priced instruments that are created, yet those instruments are significantly more vulnerable to systemic risk than simple equities, etc.
Blog spam that is effectively just a gish gallop of weak points that are each contentious on their own and it uses citations of Seeking Alpha which is about as good as a citation of Medium.com.
Companies borrow money to buy back their shares because they can borrow for long terms at interest rates below the long term of inflation.
They've buried the lede. In the last sentence, in the last 6 words.
> With Corporate profit growth unmasked and the Baby Boomer’s transition into retirement, it seems unlikely that stocks will make a quick return to their prior levels unless governments engage in massive asset inflation.
It is not the Federal Reserve's mandate to inflate asset values, however it tends to be a consequence of their mission to support low unemployment and some stable, positive inflation. We have $6 trillion in emergency stimulus arriving shortly -- two thirds of that support is monetary policy.
The first thing you learn in accounting school is which numbers are real (revenue) and which are made up (profit).
I find this scary and telling.
"It is too early to say where the bottom is to this recession, but we have reason to believe the Millennials and Generation X do not have the resources to purchase the stock that Baby Boomers want to sell at prior market highs. With Corporate profit growth unmasked and the Baby Boomer’s transition into retirement, it seems unlikely that stocks will make a quick return to their prior levels unless governments engage in massive asset inflation."
It's almost like bankrupting a generation by forcing them through punishingly expensive higher education, obscene healthcare costs, absurd cost of living in major metropolitan areas, and stripping worker benefits makes an entire generation of this country's youth unable to prosper like their predecessors. I truly have no idea what will be left behind for me and my peers, when all of this is said and done.
Well it's now clear that the Fed IS willing to engage in massive asset inflation. Nothing will stop that until the USD starts to significantly depreciation. Unlimited QE is essentially current debasement, but being the world's reserve currency provides protection.
Corporations are the largest net purchasers of stock. The narrative was never "generations of ordinary people will support prices". Because ordinary people control proportionally small amount of the nation's total wealth.
But those stock prices can never go down because of how much generational retirement wealth is locked up in financial markets.
I don't see how this addresses the comment you're replying to.
The last month of cliff-fall would suggest your premise is wrong: prices absolutely can go down.
I should amend my point to say that stock prices cannot acceptably fall without massive intervention by the government. The system is set up so that those who have the most invested in the market (mostly the older generation who are trying to retire, institutional investors, high net worth individuals) will do anything to prop those prices up, and the government will listen because it's beholden to the interests of the older and the wealthy. They'll bankrupt this nation's economy for those that will inherit it to save those retirement funds at the benefit of wealthy investors.
> unlikely that stocks will make a quick return to their prior levels unless governments engage in massive asset inflation.
I agree with you, and I'm especially concerned about this "unless". Markets are supposed to reward accurate predictions, but I would not be willing to put my money where my mouth is now. How can we trust the stock market will not be massively manipulated by the US government, by bailouts, and by measures like stock buybacks?
Your average Gen-Xer is 50+ years old today, so your very bleak picture fails to acknowledge that they've also been the benficiary of all the public expenditures and national debt that funded it.
Outside of the US Millenials have enjoyed cheaper (when adjusted) education than ever before and better healthcare. I think you paint an unnecssarily bleak and defeatist future (coming from another in a similar situation)
> Outside of the US Millenials have enjoyed cheaper (when adjusted) education than ever before
Do you have a source for this? Considering the disparity between nations, that seems to be painting with an overly broad brush.
I can't find the link, but an economist made the argument that college has gotten cheaper because although costs have gone up so has its utility. So it's a "more for your money" sort of situation. I personally don't subscribe to this view and it's not something one can simply state as a fact.
Similar to how say an automobile's year-over-year price may have increased by 5% but the adjusted value is 2% because last year's models didn't have side airbags as standard or something like that.
Given that the current sentiment seems to be that vast majority of college degrees are either worthless or simple table stakes to be able to participate in a white collar vocation I wouldn't say I follow that view either.
Well fear not: Boomer private retirement accounts don't hold most of the stocks.
What's really going to be challenging for capitalists is losing the whole "It's good for your 401K!" justification when nobody actually owns enough stock to care. Only 45% of millennials have retirement accounts and only 33% of millennials have one they are actively contributing to[1]. The median balance also shows them getting a late start [2].
[1] https://www.businessinsider.com/millennials-saving-for-retir... [2] https://www.investopedia.com/articles/personal-finance/01061...
Defined benefit pensions for government employees are invested in the market too, and everyone is exposed to that risk by way of being subject to taxes.
Some of your gripes are valid, but:
> absurd cost of living in major metropolitan areas
I fail to see how this is the Boomers' fault. Cosmopolitan urban life is a choice, often fiercely defended by Millenials on account of access to "culture", which frequently boils down to a wide diversity of differently-decorated venues in which to get drunk.
Sure, suburban life is boring, and living in the country is hard. But it's not a choice your Dad or your guidance counselor made for you.
It's not access to culture, it's access to job opportunities and avoiding a commute on highways absolutely clogged to the brim with commuters.
Boomers get the blame for capturing regulatory agencies in zoning and housing construction and preventing growth in cities in like SF.
I don’t think non Boomers are any better about it. When push comes to shove, everyone wants their kids to go to school with other kids whose parents earn as much or more, so the situation will tend to non dense housing as long as there is a wide wealth/inequality gap.
The root cause is technology obviating many jobs and letting labor from around the world compete with the same labor in the US.
Obviously if middle class people live like kings in the US compared to 90% of the world where people don’t have single family homes with garages and two cars, then there exists a tremendous arbitrage opportunity which will have to be taken advantage of if a business/country wants to remain competitive globally.
[flagged]
Please don't post flamebait to HN. Generational flamewar is particularly unwelcome here.
You've done this repeatedly:
https://news.ycombinator.com/item?id=21725642
https://news.ycombinator.com/item?id=21597613
https://news.ycombinator.com/item?id=21594517
https://news.ycombinator.com/item?id=22705734
and we've warned you before: https://news.ycombinator.com/item?id=21732554.
Continuing will get you banned, so please don't.
Serious? Good luck with that because in 30 years the 25 year old know-it-alls will be saying the same thing about your generation. The cycle never ends.
I don't think it will be so straight forward as that. Power is handed down, and people who have power generally don't want to give it up.
This is a good point, but I've been getting the feeling that the working class is getting more and more fed up with our conditions as we're squeezed for every last dollar of surplus value.
At the end of the day "the people in power" have power because the masses allow them to. If enough people refuse to participate in the system then the system will fall apart - e.g. the state only has the capacity to process so many evictions. This pandemic has been the greatest catalyst for class consciousness that I've seen in my life, and I think it has the potential to reshape our society after it's over.
I agree that this might catalyze awareness. But the people in power know they need the mass acceptance to stay in power. Which is why every new medium that reaches a big enough audience is infiltrated with agenda pushing content. It is absolutely critical to divide the masses to stay in power. It doesn't matter which side, as long as you have one side to identify with and another side to blame in this post-factum society. The percentage of people dropping out of the belief systems and trying to rationalize again is IMHO too small for large scale effects to not allow the people in power to continue. Its a handful of swing states that matter.
That being said, I have more hope for smaller, local circles, because then the partisan lines get blurry due to a common local identity.
Remember this joke?
‘A banker, a worker, and an immigrant are sitting at a table with 20 cookies. ‘The banker takes 19 cookies and warns the worker: “Watch out, the immigrant is going to take your cookie away.”’
If the ruling class plays it right the working class will go after each other instead of the ruling class. And so far they seem to do really well.
Hah! I've never actually heard that joke but it's a good one.
And yes, that is definitely what they'll do - every time something major happens in our society I've observed the mass media following the playbook from Chomsky's "Manufacturing Consent" almost exactly.
That being said, every "big event" is an opportunity for mass radicalization of the working class and these "big events" are happening more and more often. It's like the quote from the IRA: "We only have to be lucky once. You will have to be lucky always".
Electing Trump was already a response to these events but unfortunately people chose a billionaire who mainly cares about themselves. The Russian revolution and the nazis were also a response to events but in either case the people made bad choices....
“the young will be left to rebuild a more intelligent and caring society.”
Make sure they really do this. The boomers started out with “love and peace” before they turned to “greed is good”. I can easily imagine the next generation to create an even tougher society if they aren’t careful.
Ah the misguided enthusiasm of youth.
You'll grow up, don't worry.
It will amaze you how much smarter your "boomer" parents get as you get older.
This crosses into personal attack. Please don't do that, regardless of what someone else posted.
I'm sure you meant it in an avuncular way, but that doesn't translate so well on the internet.
No, that's not a personal attack. "Ok Boomer" is personal attack in a lot of places, but I guess not here...
It's banter, it's common on the internet, it's been common on the internet for decades.
I've chided the other commenter for dropping the "Ok boomer" trope here. It's definitely not ok.
Every time I see an HN analysis of the stock market, I hesitate to click it. It's only one-degree better than bitcoin spam memes on reddit.
For example, the above paragraph is completely hollow until it gives some numbers. What % of the stock is held by boomers retirement funds? (is it 1% of the market volume? 10%?)
A half-analysis is no better than no analysis.
This wins today's award for least necessary question mark.
I refuse to upvote on principle a one-liner quip on this site. But you're right, the insincere pretense of a question gives the air of a phony attempt at objectivity.
Of course, that's entirely independent of whether the points are valid or not.
Conspiracy Theories R Us.