That was my reaction to reading this.
Brian Lockhart says, “The payout ratio for S&P companies was $200 billion more than GAAP earnings. Companies are borrowing money to buy back stock to drive up earnings-per-share. How do they pay that back? They have to take future earnings in order to pay back the debt they’re using.”
In my talk in Oslo on bubbles, I said that whenever asset prices are high relative to some historical pattern, there are always two narratives available. One narrative says “Bubble.” The other narrative says that historical norms have been superceded by new patterns. In other words, “This time is different.”
I do not have a strong view about which narrative best fits the current stock market.* I do take it as given that the ratio of share prices to earnings is on the high side relative to historical norms.
*My portfolio has for quite some time been relatively light on stocks, but I have not bailed completely and not gone short.
Well, what about option c) both a & b are true ?
The 0% interest rate is a huge historical anomaly, so “this time really IS different”, at least some. But if this is the case, it’s likely to be some bubble, too.
The dot.com bubble really was different (Amazon shows this; Google a bit later), but was also a bubble.
Is the ratio of prices to earnings historically high when corrected for low interest rates?
Probably not, but here is the thing a lot of stock investors are missing- these high prices pretty much guarantee that the future returns in excess of the risk-free rate are going to be corresponding low- just like that 10Y Treasury rate. However, how many pension funds can survive without realizing that common 7-8% equity return they are assuming going forward?
Are they borrowing short or long? Short is a play on leverage and increased risk. Long is a play on a bottom in rates and a brighter future.
Firms aren’t that leveraged. I think these payout ratios are probably using gross buybacks without adjusting for stock issues and exercised options. The adjusted data I have seen looked pretty normal.
My theory is that things might be different this time- you have the central banks buying financial assets hand over fist even as we write. For the Fed, it no longer is just Treasury issues, but MBS. For the BoJ, they have been buying equities for some time, and the Swiss Central Bank also buys corporate equities. The ECB is ready to start buying Euro-denominated corporate bonds. It is only a matter of time and the next potential crisis before it becomes wide-spread buying of US corporate bonds and equities. I can easily imagine a future Fed Chairman putting an open-ended bid under the stock market or the corporate bond market to halt a crash or default wave. We are headed into uncharted territory.
Easy, they don’t have to pay it back. A stable business with predictable cash flow can move from fully equity funded to funded by 10%debt/90% equity, 20/80, … and maintain that leverage ratio indefinitely. It’s a natural response to low interest rates, reduced returns, and reduced risk.
The problems come in when the leverage ratios get too high or when it affects businesses whose failure has systemic economic consequences. you won’t notice if your bank’s landlord goes bankrupt and reorganizes but you will if your bank does.