Hollowing Out Our Economy

With obscene valuations, US stocks are far too expensive and promise to fail to advance over the next decade. That's the conclusion of value investors, who see the current business cycle as greatly extended and due for a crash in the stock market. The reasons why are easy to see: stock buybacks have boosted prices while reducing capital investment and productivity. The US stock market is in for a long decline. The details can be read in Wall Street Gamblers At Work—–U.S. Firms Spend More On Buybacks Than Factories. Here's the bottom line: An analysis conducted for The Wall Street Journal by S&P Capital IQ shows that companies in the S&P 500 index sharply increased their spending on dividends and buybacks to a median 36% of operating cash flow in 2013, from 18% in 2003. Over that same decade, those companies cut spending on plants and equipment to 29% of operating cash flow, from 33% in 2003. At S&P 500 companies targeted by activists, the spending cuts were more dramatic. Targeted companies reduced capital expenditures in the five years after activists bought their shares to 29% of operating cash flow, from 42% the year before, the Capital IQ analysis shows. Those companies boosted spending on dividends and buybacks to 37% of operating cash flow in the first year after being approached, from 22% in the year before. Capital spending by businesses accounts for about one-eighth of all spending in the U.S. economy. Historically, it has been an important driver of long-term growth, as upgrades make workers and companies more productive, says Michael Feroli, chief U.S. economist at J.P. Morgan Chase & Co. Money plowed into dividends and buybacks doesn't disappear from the economy. Its recipients can spend it, too. But Washington University's Mr. Fazzari says that most stock is owned by the wealthy, who tend to save more of their income. By contrast, he says, many kinds of business investment—from building construction to equipment maintenance and purchases—involve payments to contractors and suppliers who pay wages to middle and low-income workers. Many companies have made changes while under no direct threat from activists. General Electric Co.'s institutional investors had long urged the conglomerate to scale down its large lending business. In April, GE said it would sell off that business and buy back $50 billion of its stock. The surge of activism has sharpened the debate about the fundamental purpose of a company. Does it exist to satisfy shareholders or does it have an imperative also to try to build for the long term? The answer is far from settled. If the activists are right, they are stopping companies from throwing good money after bad. "If they aren't, then we have to worry about the impact," says Yvan Allaire, the executive chairman of the Institute for Governance of Private and Public Organizations. "It has to be a fairly significant impact on the economy.

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