Date published: 19 February 2019
Link To FT.com: https://www.ft.com/content/d6ec0bb8-343b-11e9-bb0c-42459962a812
We know that changes in the household sector balance sheet, particularly in relation to the balance between savings and consumption, matter greatly for the real economy. That said, what is unusual at present is that the exposure of US household balance sheets to the stock market is running at record levels. This is an under-acknowledged part of the explanation for the recent weakening of economic data and especially the spectacular decline in retail sales.
As TS Lombard, a research firm, points out, share prices are not the only determinant of spending but they count more than they used to because equities make up a bigger percentage of household net worth than real estate for only the third time since the end of the second world war. An important difference in the current cycle compared with the previous two occasions is that so much of the increase in ownership reflects net purchases as opposed to simply being the passive result of a valuation uplift in a strong bull market.
While not immediately apparent at the time, the sharp downturn in equities in December delivered a negative wealth effect. Part of the impact will no doubt be reversed as equities have recouped much of the lost ground since the start of the year. While the chief short-term determinant of equity prices will be perceptions about monetary policy and the outcome of the China-US trade talks — and in Europe, worries about Brexit, populism and political risk as the EU parliamentary election approaches — investors would do well to remain conscious of the close relationship between markets and household behaviour.
More important in the long run, though, is the shifting balance in purchasing power between institutional investors and the corporate sector. According to consultants Willis Towers Watson there has been a 20-year decline in equity ownership by pension funds across the globe. In seven countries with the biggest pension funds the fall has been from 60 per cent to 40 per cent of the aggregate portfolio over the period. At the same time investment in real estate and alternative assets such as infrastructure and private equity have risen from 7 per cent to 26 per cent. Bond holdings have remained steady at 31 per cent.
This has coincided with a decline in the role of public equity markets in the developed world. The number of listed companies in the US, per million of population, halved between 1996 and 2012. A recent paper from the CFA Institute attributes much of this change to a shift in the structure of a corporate sector that is increasingly driven by investment in intangible assets. This, it says, has important implications for public markets because companies based on intangible asset development tend to get bigger very rapidly and have little need for capital. They prefer to deal with fewer but larger investors to retain ownership and control over easily copied intangible assets for as long as possible. They have been helped in this by changes in regulation and the global search for yield.
This is, though, a strictly developed world phenomenon. Research by the OECD highlights a record 1,074 listings in Asia in 2017, of which 470 were in China. Some 90 per cent of the companies were non-financial. That of course fits with the story of globalisation. In effect, the developed world has outsourced much of its capital-intensive industry to the emerging markets. At the end of 2017 Asia accounted for nearly half the world’s 50,000 or so listed companies, with about 40 per cent of global market capitalisation.
To return to the flow of funds into equities, it is the corporate sector, not households, that really matters in the long run. While institutional investment in equities has fallen — and seems likely to go on falling as pension funds increasingly match their liabilities with bonds — companies have turned into the biggest buyers of equities through stock buybacks, mergers and acquisitions.
There is logic in the growth of buybacks because investment opportunities for mature businesses in the developed world are dwindling in relation to cash flow, even if too many shares are bought expensively in the interest of bonus-boosting uplifts for share prices and earnings.
For investors these shifts in capital market behaviour may nonetheless carry a sting in the tail. Buybacks in the US are increasingly being financed by borrowing. Many corporate borrowers survive only thanks to the emollient policies of central bankers. Investors should also note that the two previous occasions when household balance sheets were so heavily exposed to the stock market were at the peak of the late-1960s bull market and at the top of the late 1990s dotcom bubble.
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