Apple, the Fed and the financial fallacy
By James Saft
(Reuters) – Apple’s emphasis on share buybacks is a strikingly similar error to the Federal Reserve’s dedication to buying U.S. Treasuries.
Call it the financial fallacy, the modern tendency to concentrate on the often ephemeral movement of numbers on traders’ screens rather than the much harder to manage real world.
Both institutions are reacting to deteriorating fundamentals by concentrating their firepower on influencing securities markets.
Sadly, you usually do better by improving the fundamentals in order to influence markets rather than trying to change the markets to improve the fundamentals.
Both Apple and the Fed might be better off simply putting more money directly into the hands of their stakeholders, in the case of Apple via dividends and in the case of the Fed by simply doling out cash to citizens.
Apple, sitting on a $145 billion cash hoard but facing declining margins and a drought of new blockbuster products, unveiled a $55 billion increase in plans to return cash to shareholders. The money, which will be distributed through 2015, was heavily slanted towards share buy-backs. Apple increased the size of its share buy-back program to a record-breaking $60 billion, from the $10 billion already planned, while using the remaining $5 billion to increase its dividend by 15 percent.
Big numbers, but investors chose to concentrate on flagging growth and falling profit margins, bidding down shares in Apple to near 17-month lows, more than 40 percent below 2012 peaks.
The Fed, for its part, has been engaged in a five-year Herculean struggle in which it tries, by buying Treasuries and mortgage bonds, to drive asset markets higher and make us all giddy and willing to spend. The play is simple – buy up bonds, thereby driving down interest rates. That will tend to make borrowing money more attractive and drive up asset prices. The hope is that, at the end of this long chain of transactions, each one involving a payment to an intermediary, some poor sap will decide to buy a new car or take a vacation because his house and shares have gone up in price.
Clearly there are differences; the Fed can mint cash while Apple merely earns it. Still, both institutions nicely illustrate the extent to which we live in a financialized society, one with huge incentives to create paper wealth and less well-developed ones for sustainable growth.
In choosing to emphasize buybacks over dividends, Apple is following a trend but ignoring history.
While share buybacks have surged in popularity, research by James Montier at GMO shows that since 1871 dividend yields and dividend growth have accounted for 90 percent of equity returns. But dividends only win out over the longer term; over a one-year time horizon changes in valuation – what investors will pay for a given dollar of earnings – drive 80 percent of equity returns.
Much of the move away from dividends in recent years and towards share buybacks can be accounted for by looking at how executives are paid. Stock options don’t reward executives for producing total returns over the long run, they pay them for driving share prices higher over two- or three-year periods.
After all, an option holder gets nothing from a dividend increase but gets a massively increased payday from a substantial share price movement.
Dividends for investors are also real cash which you can pocket and walk away. Buybacks, on the other hand, can always be counterbalanced by share sales later.
Apple shareholders would probably be better served if more of the cash went directly back to them or was used for the kind of research or acquisitions which will create growth.
In the same way, the Fed may be better off turning away from quantitative easing, which buys up financial assets, and towards something which would allow people to more directly retire the debts which are holding back spending and growth.
Australian economist Steve Keen has long advocated a “modern debt jubilee” which would put money directly in the hands of households rather than funneling all through financial markets.
Dividends and dole-outs like the jubilee have huge advantages. They cut out middle-men, like executives, bond brokers and the like, putting cash directly in people’s hands. And they allow the money to be spent or invested by those on the ground with the best view of the action and the fewest conflicts of interest.
In the end, I’ll bet on shareholders and citizens as asset allocators above Apple executives and Fed chiefs.
(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at email@example.com and find more columns at blogs.reuters.com/james-saft)
(James Saft is a Reuters columnist. The opinions expressed are his own.)
(Editing by James Dalgleish)