Believe it or not, that smartphone in your pocket has more computing power than all of NASA circa 1969. Okay, so it won’t get you to the moon but it can get you a pizza, or anything else. The silicon revolution that spawned the internet has created global companies and upended centuries-old industries. It’s the kind of creative destruction Schumpeter would appreciate, making us (labour, that is) more productive and the companies in which we invest more profitable.
Except that there’s no evidence of that actually happening, at least not since the 1990s. Earlier this month the US announced that non-farm productivity fell for the third consecutive quarter, the longest period of decline since 1979. It’s strange, don’t you think? Here we are in the midst of a transformative era of Uber, AirBnB, gene splicing and coffee cups that give you a kiss* – and the country that’s leading the way is experiencing falling productivity.
Theories abound as to why; from lazy workers and poor data to income inequality and under-investment (a story I will one day get to). Facebook investor Peter Thiel is so concerned he’s lovingly published a beautiful online lament (one must be careful about what one says about dear Peter), titled ‘What happened to the Future?’ It claims the rate of technological innovation is actually slowing, which is why we got Twitter’s 140 characters instead of flying cars.
The truth is more banal; no one really knows why productivity growth has been in long-term decline.
The Treasury chart shows Australia’s performance is better than most, although that’s not saying much. It’s been decades since Western countries experienced the rates enjoyed in the 1950s and ’60s. We might be transitioning away from the mining boom with some success, via an investment-led property boom, but slow productivity growth is a global problem.
This issue looms large over negative interest rates, currency wars and sovereign debt; all of which would be less of an issue if productivity growth were stronger. Rising productivity drives increases in household income, which boosts economic growth and corporate profits. In the long run we can’t expect dividends to increase without it. And yet dividends have been increasing faster than corporate profit growth.
Higher dividend payout ratios mean lower levels of reinvestment but that’s what investors demand, sacrificing higher future income in favour of cash right now. And companies have all the excuses they need to comply. Hurdle rates are ridiculously high compared with interest rates and they, like their customers, are worried about the future. Why not spend earnings on mergers, acquisitions, share buybacks and dividends? So, enjoy the sounds of those fat cheques hitting the doormat over the next few months, they may not be quite as high in years to come.
Reading between the lines, Commonwealth Bank chief executive Ian Narev might hold a similar view. At the bank’s recent results presentation he said that “dividends are not annuities”, a bland statement of fact but a rebuke of sorts to dividend-chasing investors. Our banking analyst, Jon Mills, meanwhile, believes the big banks “are going to find it tough to raise earnings and dividends over the next few years”.
It’s a common view among brokers and fund managers and has been for quite a while. Increased capital requirements and regulatory costs, potentially higher provisioning and slower credit growth could be a drag on the sector’s earnings. Last week, corporate trailing indicator Moody’s joined the slumber party, putting the sector on a negative credit outlook – not an actual downgrade but the threat of one.
Bank shareholders shouldn’t be too concerned. InvestSMART’s research director James Carlisle, who excitedly told me yesterday the banks are within spitting distance of joining the Buy list, certainly isn’t. If investors are reaching for yield, they’re not leaning the banks way.
Perhaps a change is afoot. Wealth manager IOOF Holdings and conglomerate Wesfarmers, both of which in the past have registered extremely high dividend payout ratios, recently announced dividend cuts. Neither were punished for it, which is as it should be. Dividends should reflect the state of a company’s finances and the opportunities it has to reinvest capital. When boards get hung up on maintaining dividends bad decisions can be made on both those fronts.
Kudos, too, to BHP Billiton, where management rather than mine-quality is the problem. It has committed to pay out at least 50 per cent of underlying earnings as dividends. With one hand tied behind its back the company’s capacity to make more overpriced acquisitions is therefore halved. Sometimes, a company unable to reinvest too much capital is a good thing.
There’s another lesson here, too, one that might be echoed in the banking sector should a credit downgrade actually occur. Deputy research director Gaurav Sodhi, in his review of BHP, put it thus: “It’s not good enough to wait for improvements in business conditions before buying shares. Uncertainty and pessimism are what create opportunity and expectations will always lead reality.” Investors aiming to outperform the market must lead, and we can’t do so from the back.
Another factor evident this reporting season is the effect bond yields are having on growth. Low bond rates have caused a weird reversal, one where bonds are purchased for capital growth and shares for income. Highly-leveraged, tick-tock infrastructure stocks like Transurban and Sydney Airport, plus just about every Australian Real Estate Investment Trust (AREIT) you can think of, have enjoyed huge share price increases as a result. We’re currently at the point where high yield usually implies higher share price risk.
Now it’s the turn of growth to get a little love. Earnings growth expectations were low this reporting season and any company that managed to beat them, even by a bit, has benefited. ASX and Trade Me – the latter still on our Buy list and the former only recently removed from it (disclosure: I’m a shareholder) – are good examples. Whether this is the return of common sense or an early preview of another episode of crazy we’ll just have to wait and see.
All of these examples, though, point to the incredible influence the bond market is having on share prices. Bond yields that are either negative or in low single digits are the widespread numerical expression of Larry Summers’ belief in secular stagflation. In non-economists speak, that means structurally lower global growth, accompanied by lower-for-longer rates as a consequence. So common is this thesis it’s hard to find anyone of note that contradicts it. Right now “lower for longer” seems the epitome of a cheery consensus, which is perhaps the best reason to worry about it. Time to kiss the coffee cup for good luck perhaps?
*Korean designer Jang Woo-Seok’s ‘Human Face Coffee lids’:
