The financial behaviour of the corporate sector in the two largest economies in the developed world has been extraordinarily risk-averse in recent years. In the US, companies have been saving more than they invest, showing a marked disinclination to put money into illiquid long-term assets. As well as accumulating cash on the balance sheet, they have been stepping up their investment in share buy-backs.
Japanese companies have also been saving furiously. While Japan’s household sector has run down its savings as a percentage of disposable income from 10 per cent in 1999 to less than 3 per cent today, the national savings rate has held up at about 25 per cent because of the increase in corporate savings. In a shareholder-unfriendly corporate governance system, Japanese boards pay out much less in dividends than their US counterparts and are only tentatively engaged in buy-backs.
Alan Greenspan, former chairman of the Federal Reserve, argues that the decline in the share of liquid cash flow that US companies choose to allocate to illiquid capital investment stems from uncertainty in business arising from the surge in government activism since the collapse of Lehman Brothers.
But if they think the Obama administration is likely to impair the value of any capital investment they make, why are business people bidding up the value of their stock through buy-backs, which increases their exposure to their own existing illiquid assets that would presumably be vulnerable to the same uncertainty?
As Brad DeLong of the University of California at Berkeley argues – more plausibly in my view – business is reluctant to invest because capacity utilisation is low and demand for its products is weak. There may also be a structural explanation for the weakness of investment in Japan as well as the US in that business has been putting more investment into foreign subsidiaries in emerging markets.
Yet risk aversion is really yesterday’s story, not least because of the Sendai earthquake. Before the quake, the Organisation for Economic Co-operation and Development was projecting that growth in real private non-residential investment in Japan would rise from 1.8 per cent in 2010 to 4.6 per cent this year and 5.5 per cent in 2012. The enormous reconstruction effort that will now be required means that these numbers will prove conservative and the economy will see some rebalancing towards domestic demand.
As for the US, the extent to which business acts as a net lender to the rest of the economy is already on a marked downward trend. Net lending by business peaked in the third quarter of 2009 at the freakishly high level of $730bn and has declined quarter-by-quarter to $414bn in the third quarter of last year.
The figures will fall much further in 2011 because the US is heading for an investment boom stimulated by the administration’s enhanced depreciation allowances in the stimulus package at the end of last year.
It is clear that the corporate sector’s risk aversion has been substantially to do with the shock of the greatest recession since the 1930s. And it seems likely that a lower level of corporate saving, at least in the US, could have significant fallout in the markets. For if more is going into capital investment, there will be less cashflow available for buy-backs, which are an important driver of equity market values. Note in passing that, while buy-back decisions are supposed to be part of a straightforward capital allocation process in which managers weigh the respective returns on stock market equity versus direct capital investment, the historical evidence suggests managers have poor market judgment, tending to buy high and sell low.
It could be that the latest buy-back flurry is an example of precisely that. As a preference for illiquid assets now reasserts itself, the going may become much tougher for equities as the year progresses.
How this change in the corporate sector’s asset preferences will affect Japanese equities is less easy to predict because the Japanese market tends to go its own way and follow its own rules.
Buy-backs are not a significant influence on the level of the market. And while Japanese companies still hold large chunks of other companies’ equities on their balance sheets it does not necessarily follow that they will dump equity now.
Meantime, little has changed in the corporate governance environment to put pressure on boards to increase dividends. Yet from the point of view of foreign investors, this has become relatively academic given that the dividend yield on Japanese equities is now higher than on US equities.
After the Sendai earthquake, Japanese equities appear to offer both value and diversification in a world short of undervalued assets.
The writer is an FT columnist