Stocks are rising slightly on Thursday, with the Dow Jones Industrials Average (DJINDICES:^DJI) and the broader S&P 500 (SNPINDEX:^GSPC) up 0.22% and 0.24%, respectively, at 12:05 p.m. EDT. Three Dow components that together represent broad consumer and industrial demand reported quarterly earnings before today's opening: 3M (NYSE:MMM), Caterpillar (NYSE:CAT), and Procter & Gamble (NYSE:PG). Results -- and the market's reactions -- were mixed.
On earnings per share, only Caterpillar produced a "beat" (it also raised its full-year forecast), with Procter & Gamble in line with the consensus forecast and 3M falling short of the mark. On revenue, Caterpillar again was alone in exceeding Wall Street's expectations. (This illustrates a phenomenon I highlighted in Tuesday's column, whereby S&P 500 companies appear to be struggling to meet analysts' revenue forecasts during this earnings season.)
3M, which lowered its full-year guidance range by $0.20, to $7.80 to $8.10, is attracting the strongest reaction in the market, with shares down 2.6% at 12:05 p.m. EDT.
Welcome to the era of "capital recycling"
Japan's Nikkei 225 index closed above 20,000 yesterday -- its highest level since the heady days of March 2000. One catalyst for the recent gains in Japanese shares is part of the Abe government's "third arrow" of structural reform, including improved corporate governance and a new focus on capital return to shareholders.
Last month, for example, notoriously secretive industrial robot maker FANUC said it would consider raising its dividend and buying back shares. The company hit the headlines in February after activist investor Daniel Loeb disclosed that his fund, Third Point, had established a position in the stock, but FANUC maintains that its decision is unrelated to Third Point.
While I applaud this orientation in Japan, the process has its limits, and -- surprise! -- the U.S. corporate sector may now be providing an example of just that. With nearly 30% of S&P 500 companies reporting earnings this week, many will announce increases in dividends and share repurchase programs. Indeed, buybacks and dividends for the S&P 500 are now expected to exceed $1 trillion this year.
Finance blogger Jesse Livermore (@Jesse_Livermore on Twitter) has done yeoman's work to increase understanding of long-term equity returns in the U.S. His most recent blog post looks at the effects of "capital recycling," and his prognosis is sobering:
In past markets, corporations grew EPS by investing in organic business growth, which isn't affected by the market's valuation. The current era, however, is characterized by a reduced emphasis on organic business growth, and an increased emphasis on EPS growth through share count reduction -- what is perjoratively termed "capital recycling."
Currently, almost 100% of S&P 500 EPS is being devoted to capital recycling–some combination of dividends, buybacks, and buyouts. The growth that this recycling will produce will be entirely determined by the market's valuation–nothing else can make a difference to it but that. And so if these simulations in historical data are telling us that we should mark down our future return expectations by 25% to 33% of the historical norm, then we should probably mark them down by an even greater amount, because the underlying allocation practice through which they will be driven down–capital recycling that occurs in lieu of organic business growth–is significantly more prevalent now than it was in prior eras.
That assessment is no cause for alarm per se, but it's another reason some investors might wish to revisit their assumptions regarding the long-term returns they expect to earn in the stock market.