Strategy I: Dividends for Stocks. Joe and I have been monitoring the flow of funds into the US stock market for a very long time. We’ve frequently noted that the current bull market has been primarily driven by corporations buying back their shares and paying out dividends, which tend to be used by their recipients to buy more shares. We also started to observe in early 2017 a significant increase in money pouring into equity ETFs.
We were intrigued by a 3/29 Bloomberg story titled “Stocks Are About to Get a $400 Billion Dividend Boost.” It was based on a research note by Morgan Stanley strategists. They report that as much as $400 billion is set to be paid to investors between March and May. They state, “April in particular tends to be a strong month for global equity returns.”
That might be one reason why the adage about “Go away in May” might work on occasions, especially if spring performance has been particularly good. Joe will have a closer look at this notion after he comes back from visiting colleges with his daughter this week.
The Bloomberg article’s headline number seemed awfully big to us until we read that it’s the dividends that are likely to be paid on equities around the world. Before he went on his road trip, Joe reported the following to me:
(1) Global companies usually pay semiannually, while US corporations typically pay dividends either quarterly or semiannually.
(2) Gross dividends in the US for the S&P 500 totaled $108.95 billion in Q1-2018, down slightly from $109.09 billion in Q4-2017 (Fig. 1). US dividends are roughly 40% of the MSCI AC World total.
(3) S&P 500 dividends totaled $424 billion last year using Thomson Reuters data, which are based on the composition of the current index. Thomson Reuters analysts expect $450 billion in 2018, up 6.2% y/y, and $486 billion in 2019, up 8.0%.
(4) We both expect that the corporate tax cut enacted along with the Tax Cut and Jobs Act (TCJA) late last year will be reflected in a permanent one-shot increase in the level of dividends. So the growth rate in dividends is likely to be higher in 2018. The TCJA will also temporarily boost repatriated earnings, which are likely to lift share buybacks more than dividend payouts.
(5) There is definitely a seasonal pattern in S&P 500 dividends: They’re often down in Q1, because Q4 typically has a boost from “special” or one-time dividend bonuses, and higher in Q2 and Q4 because of semiannual and special dividends.
During the 54 years from 1965-2018, the Q1-is-less-than-Q4 pattern holds true 45 of the 54 years. Q2-Q3-Q4 dividends are typically sequentially higher q/q, with Q2 and Q4 boosts more likely than Q3 ones.
Strategy II: Buybacks & Dividends. Corporations like to please their shareholders and attract more of them by paying out some of their after-tax profits in dividends. Ideally, they like to increase their dividends every year in a predictable fashion. That’s hard to do during recessions, but tends to be the norm during economic upturns, as can be seen by the steady uptrend in S&P 500 dividends during the current and previous economic expansions (Fig. 2).
Corporations also buy back their shares as a way of rewarding their shareholders. This practice tends to be much more cyclical than dividend payments (Fig. 3 and Fig. 4). Let’s have a closer look at the data:
(1) Dividends vs buybacks. Dividends rose to a record high of $436 billion last year using S&P’s measure, which is the sum of the year’s four quarters calculated with the actual, rather than the current, composition of the S&P 500. They’ve been on a steady upward trend since mid-2010. Buybacks slowed to $548 billion over the past four quarters through Q4-2017, down from a comparable cyclical high of $646 billion during Q1-2016.
(2) Dividends plus buybacks. The sum of dividends and buybacks has stalled around $940 billion, based on the four-quarter sum of this series since 2014. During the previous bull market, this sum peaked at $834 billion (Fig. 5).
(3) Operating earnings vs buybacks plus dividends. Last year, the S&P 500 companies had operating earnings totaling a record $1,066 billion, while buybacks plus dividends totaled $938 billion (Fig. 6). The ratio of the latter to the former suggests that corporations have been paying out roughly 100% of their after-tax operating earnings to shareholders through dividends and buybacks over the past couple of years, leaving virtually nothing for capital spending. That’s an erroneous conclusion since operating earnings tends to be a small fraction of cash flow, which is the sum of retained earnings and depreciation expense.
Strategy III: ETFs and Foreigners. Another important source of funds into global stock markets since early 2017 has been net inflows into US-based active and passive funds, especially ETFs. Interestingly, despite the sharp drop in stock prices during February, equity mutual funds and ETFs saw net outflows of only $19.0 billion during the month (Fig. 7). The 12-month net inflows have been hovering around $300 billion since mid-2017 (Fig. 8).
On a 12-month basis, net inflows into equity ETFs well exceeded the net outflows from equity mutual funds. Among equity ETFs, funds that invest only in domestic equities continue to attract sizeable inflows but at a pace that’s been slowing since early 2017 (Fig. 9). On the other hand, money is pouring into US-based ETFs that invest globally at a record pace, rising to $173.6 billion over the 12 months through February.
Foreign investors may be starting to reciprocate the favor by purchasing more US equities. The Fed’s data compiled in the Financial Accounts of the United States show that the “rest of the world” bought $134.3 billion in US equities last year, the best pace since Q4-2012 (Fig. 10). They had been heavy net sellers during 2016, according to the Fed’s stats.
Strategy IV: Corporate Profits. Along with the third revision in GDP, released on March 28, the Bureau of Economic Analysis also provided a second revision for corporate profits in the National Income and Product Accounts (NIPA). The data show that after-tax book profits (as reported to the IRS) fell 6.0% y/y (Fig. 11). Not to worry: NIPA after-tax profits from current production (i.e., on a cash-flow basis) rose 4.8% y/y. The divergence was mostly attributable to the impact of the TCJA, which was also reflected in S&P 500 aggregate income, which was up 10.7% y/y on a reported basis but up 20.4% on an operating basis.
Strategy V: Cash Flow & Capital Spending. Collectively and on average over time, corporations tend to pay out roughly 50% of their after-tax profits in dividends (Fig. 12). There has been quite a bit of volatility around this average, especially for the S&P 500. In recent quarters, the NIPA dividend payout ratio has declined from a cyclical high of 68.6% to 55.5% during Q4-2017.
As a result, NIPA dividends have been virtually flat at a record high around $1.0 trillion in recent quarters (saar) (Fig. 13). Undistributed corporate profits (on a cash-flow basis) rebounded from a recent low of $464 billion (saar) during Q4-2015 to $787 billion during Q4-2017, nearly matching the record high during Q3-2010 (Fig. 14).
Thanks to the TCJA, depreciation reported on tax returns jumped by $266 billion (saar) during the final quarter of 2017 to a record $1,803 billion (Fig. 15). The result was that corporate cash flow rose to a record $2,438 billion (saar) at the end of last year. That was enough to fund stock buybacks and plenty of capital spending.
Keep in mind that some of the buybacks and capital outlays were paid for with proceeds raised in the bond market. The Fed’s database mentioned above allows us to track the sum of capital spending plus buybacks of nonfinancial corporations (their major uses of funds) to their cash flow plus net bond issuance (their major sources of funds) (Fig. 16). Not surprisingly, the two series track closely, and both have remained relatively flat at record highs over the past two years.
The data show that nonfinancial corporations had $1.7 trillion of capital expenditures last year. They had cash flow at $2.0 trillion, with depreciation accounting for $1.4 trillion (Fig. 17).
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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