If you see Sid, tell 'im
Mar. 10th, 2007 12:28 pm![[personal profile]](https://www.dreamwidth.org/img/silk/identity/user.png){kind=small}
peterbirksThere are certain macro-events in the economic world that take place over such a long period of time that one can never be sure in a single lifetime if they are a long-term trend or a long-term cycle. Of course, you might say, in the long run we are all dead anyway, so why does it matter?
Well, if you like looking at historical trends/cycles, it's useful to know which is which.
Two matters spring immediately to mind. One is the yield/differential bewteen bonds and equities, and the other (linked to the first) is the democratisation of share ownership.
Equities yielded less than bonds right the way up until 1968. This was because equities were riskier than bonds, so, obviously, they should yield less, right?
Well, yes, if you don't allow for growth. And the post-war years were manic years for growth. So, equities began to yield less than bonds, because capital growth more than compensated for the additional risk. Equities are also a better long-term defence against inflation (unless your bonds are index-linked)
Just about everyone in the business sees this as a trend rather than a cycle. The gainsayers are the long-term bears and recessionists who think that the world will go "ex-growth" at some point, in the long run. But, as I said earlier, in the long run, we are all dead.
The second long-term trend has been the widening of share ownership. If you include pension funds, well, we are all investors now with a direct interst in positively performing equity markets. But even if you exclude pension funds, a far greater proportion of the population is invested directly in equities than was the case 100 years ago.
A couple of years ago I was chatting with a guy at work who writes on money-laundering and compliance. In my normal tirade against Sarbanes-Oxley, I said that one unintended side-effect of the regulations brought in in the wake of the Enron collapse could be the end of the equity system as we know it.
This was a bit of an exaggeration, in that many companies that are taken private these days are only done with a view to a short-term financial restructuring (fans of 1830 will know the drill) before reflotation. But the KKR bid to take Boots private (announced yesterday) reflected an interesting statistic over the past three years.
Up to and including 2003, the UK equity market grew. By that I don't mean capitalisation grew every year, but that the amount of new issues outweighed the stock that was "retired" through mergers, buybacks, etc.
Then, in 2004, that trend reversed, with £16bn worth of equities leaving the market (net). In 2005, this doubled to £32bn. Last year, another £64bn, equal to 4% of the London equity market, disappeared.
One reason this is happening is linked to bonds and interest rates. Debt is cheaper relative to equity. The cost of capital is, at it were, at bargain basement price.
So, is this a trend or a cycle? We have the mini-cycle of de-equitisation, but I think there is also a longer-term shift, related at least in part to increased regulation. Time and again I hear the bemoaning of CEOs that they can't do the job they would like to do, because they are always talking to rating agencies, or to regulators, or to analysts, or to the press. Actually building up a company is almost impossible if it's listed, because there are so many other things in the way. Little wonder that management buyouts are popular and private equity takeover bids are not resisted as much as they might have been in the past.
+++++++
I doubt that George W reads this blog, but it was a bit of a coincidence that my comments on Captain America and America's puzzlement at the way the rest of the world sees it was followed yesterday by Bush saying in Brazil yesterday that "I don't think America gets enough credit for trying to help improve people's lives," and that "My trip is to explain as clearly as I can that our nation is generous and compassionate."
It's a common attitude amongst politicians that, if someone doesn't like you, it's because "we aren't getting our message across". This is a mistake. Often the message is coming across loud and clear, but the recipients don't like it. As Bush mentioned, US aid was $1.6bn last year. How, he must wonder, can the recipients not be appreciative?
And yet, and yet, they aren't. Chavez gets more cheers with "Gringo go home" than does Bush with "We gave you $1.6bn last year".
It's an old US saying that if you get them by the balls, their hearts and minds will follow. The flaw with this is that it plain isn't true. Somehow, America has lost the hearts and minds of a large number of people. And it's no use them saying "Listen, you morons, look how much we have done for you!", because, quite clearly, that message isn't working. The British who could not understand how Gandhi generated such a following in India suffered a similar cultural disconnection. I think that the US will eventually come to realize this. But, at the moment, they are losing the propaganda war, and someone from McKinsey should perhaps be brought in to advise them on reputational risk and solid brand management.
+++++++++
Well, if you like looking at historical trends/cycles, it's useful to know which is which.
Two matters spring immediately to mind. One is the yield/differential bewteen bonds and equities, and the other (linked to the first) is the democratisation of share ownership.
Equities yielded less than bonds right the way up until 1968. This was because equities were riskier than bonds, so, obviously, they should yield less, right?
Well, yes, if you don't allow for growth. And the post-war years were manic years for growth. So, equities began to yield less than bonds, because capital growth more than compensated for the additional risk. Equities are also a better long-term defence against inflation (unless your bonds are index-linked)
Just about everyone in the business sees this as a trend rather than a cycle. The gainsayers are the long-term bears and recessionists who think that the world will go "ex-growth" at some point, in the long run. But, as I said earlier, in the long run, we are all dead.
The second long-term trend has been the widening of share ownership. If you include pension funds, well, we are all investors now with a direct interst in positively performing equity markets. But even if you exclude pension funds, a far greater proportion of the population is invested directly in equities than was the case 100 years ago.
A couple of years ago I was chatting with a guy at work who writes on money-laundering and compliance. In my normal tirade against Sarbanes-Oxley, I said that one unintended side-effect of the regulations brought in in the wake of the Enron collapse could be the end of the equity system as we know it.
This was a bit of an exaggeration, in that many companies that are taken private these days are only done with a view to a short-term financial restructuring (fans of 1830 will know the drill) before reflotation. But the KKR bid to take Boots private (announced yesterday) reflected an interesting statistic over the past three years.
Up to and including 2003, the UK equity market grew. By that I don't mean capitalisation grew every year, but that the amount of new issues outweighed the stock that was "retired" through mergers, buybacks, etc.
Then, in 2004, that trend reversed, with £16bn worth of equities leaving the market (net). In 2005, this doubled to £32bn. Last year, another £64bn, equal to 4% of the London equity market, disappeared.
One reason this is happening is linked to bonds and interest rates. Debt is cheaper relative to equity. The cost of capital is, at it were, at bargain basement price.
So, is this a trend or a cycle? We have the mini-cycle of de-equitisation, but I think there is also a longer-term shift, related at least in part to increased regulation. Time and again I hear the bemoaning of CEOs that they can't do the job they would like to do, because they are always talking to rating agencies, or to regulators, or to analysts, or to the press. Actually building up a company is almost impossible if it's listed, because there are so many other things in the way. Little wonder that management buyouts are popular and private equity takeover bids are not resisted as much as they might have been in the past.
+++++++
I doubt that George W reads this blog, but it was a bit of a coincidence that my comments on Captain America and America's puzzlement at the way the rest of the world sees it was followed yesterday by Bush saying in Brazil yesterday that "I don't think America gets enough credit for trying to help improve people's lives," and that "My trip is to explain as clearly as I can that our nation is generous and compassionate."
It's a common attitude amongst politicians that, if someone doesn't like you, it's because "we aren't getting our message across". This is a mistake. Often the message is coming across loud and clear, but the recipients don't like it. As Bush mentioned, US aid was $1.6bn last year. How, he must wonder, can the recipients not be appreciative?
And yet, and yet, they aren't. Chavez gets more cheers with "Gringo go home" than does Bush with "We gave you $1.6bn last year".
It's an old US saying that if you get them by the balls, their hearts and minds will follow. The flaw with this is that it plain isn't true. Somehow, America has lost the hearts and minds of a large number of people. And it's no use them saying "Listen, you morons, look how much we have done for you!", because, quite clearly, that message isn't working. The British who could not understand how Gandhi generated such a following in India suffered a similar cultural disconnection. I think that the US will eventually come to realize this. But, at the moment, they are losing the propaganda war, and someone from McKinsey should perhaps be brought in to advise them on reputational risk and solid brand management.
+++++++++
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no subject
Date: 2007-03-11 01:53 am (UTC)And looking more broadly bonds are basically priced as a function of interest rates and creditworthiness, whereas equities are more sensitive to events and therefore more risky. Again, you expect higher returns as compensation for taking that risk.
What happens if the spread narrows? We dump our risky equities because they aren't compensating us for taking the risk and buy bonds. If we don't do it then some arbitrageur will.
The private equity "boom" is, as I see it, stemming from the perception that companies can be managed to deliver higher returns to shareholders. Higher enough that the implied equity-bond spread is widened to the point that it makes sense to borrow money to buy the shares. Well, they make it more complicated by doing the borrowing after they buy the company, and having the company take on the debt (which is a good trick) but that's basically what they're doing.
It's just a rather obvious and visible manifestation of something that goes on all the time: buying low and selling high. But it's got a new (sort of) name and a bunch of attention. And anyway, the companies tend to return to the market once they've been, um, "normalised"?
In a couple of years the Pru will have launched a Private Equity Unit Trust or some such and we'll all be joining in.
no subject
Date: 2007-03-11 04:43 pm (UTC)If a company's bonds pay 7%, and shares are riskier, then you would expect them to cost less than bonds (i.e., to yield more).
But they don't. They yield less. So, why do they yield less, if they are riskier?
They yield less because people expect them to improve over time.
The maths for this aren't that complicated (well, they aren't unless you bring the negative value of volatility into play, so, well, we won't).
We have $100 to invest for 10 years.
Corporate bonds in this company yield 7%.
The dividend yields 4%.
So over 10 years we get 70% interest on the bonds, and then get our $100 back (the fact that the money is more "upfront" with the onds also adds a bit to the total yield. Let's say, 5% over the 10 years.) So. We have $175 at the end of our 10 years.
To get more than this on the equities, one would think that one would want the dividend to increase gradually to 10% over the 10 years, (equal to about an 8.5% increase every year). But this isn't so, because we know that equities yield 4%. If the dividend increased this fast, then the price would rocket to $250, so we would not only have the same yield over 10 years as we obtained from the bonds, but also the $150 capital increase.
So, let's aim for a 35% yield over 10 years for the capital, and a 35% yield from dividends. At 4% yield a year to start, that amounts to a modest annual increase (without recourse to a calculator, I'd say about 2% a year).
So, if we put no negative value on risk, we would accept a 4% yield on the equity compared with a 7% yield on the bonds if we thought that, on average, this kind of company would grow by 2% a year and increase its yield concomitantly.
But, we know that we do put a negative value on risk. The question is, how much?
Now, if we head into the area of volatility, its valuation, and smoothed earnings, things become much more fun....
PJ
The missing link
Date: 2007-03-12 01:44 pm (UTC)The bond repays £100 on maturity. The equity should represent the ownership of the same proportion of the company, and the brick, mortar etc is inflation hedged, at least to an extent. And this doesn't allow for any investment that the company is doing.
In addition, the modern company is borrowing by issuing bonds. This means that the equity interest is leveraged somewhat, thus potentially raising the return.
no subject
Date: 2007-03-11 04:44 pm (UTC)PJ