Citi On Why QE Isn't Working

Tyler Durden's picture

Authored by Robert Buckland, Head of Citi Global Equity:

QE Isn't Working: An Equity Perspective

The economics textbooks teach us that expansionary monetary policy, which lowers interest rates and eases credit, can be used to combat unemployment and economic recession. So, with inflationary pressures waning and the world economy slowing, policymakers around the globe have put this theory into practice and continued a "race to the bottom" for global interest rates. Many of those countries with policy rates still high enough to make it worth cutting have done so. Those where rates were already rock-bottom have resorted to increasingly creative means to lower borrowing costs even further.

Low interest rates should help to support consumer spending through reduced mortgage and credit card costs. In addition, by purchasing sovereign debt, QE policies help to reduce market pressures for governments to pursue growth-sapping austerity policies. But lower rates for overleveraged consumers and governments look more like damage limitation than growth promotion.

That leaves the corporate sector as policymakers' best hope for economic growth and especially job creation. Balance sheets are strong, profitability is high and the cash is piling up. Add ultra-low rates to the mix and surely CEOs will kick off a capex and hiring binge. But this has not really been happening, in the listed corporate sector at least. In fact, capex/sales ratios for publicly listed companies across the world have been heading downwards for much of the past decade even given a backdrop of progressively lower interest rates. Recent ultra-low rates have not noticeably reversed this trend.

Faults in the transmission mechanism

Such corporate caution is usually blamed on global economic uncertainties. Amongst these, the US fiscal cliff, China slowdown and the ongoing EMU crisis look most obvious. But we can't help feeling that there is something more fundamental going on here. The economic outlook is always uncertain at weak points in the cycle. Nevertheless, low interest rates usually prod CEOs into action.

We think one answer to this conundrum can be found in the equity market itself. As aggressive monetary policy has pushed interest rates to all-time lows, so the dividend yield available on equities becomes more attractive. The global equity market now consistently trades on a dividend yield above treasuries for the first time in over 50 years. Income-starved investors have noticed.

Turning textbooks on their head

If the global equity asset class has reinvented itself as an alternative bond market, this has profound implications for companies and, ultimately, policymakers. Textbooks suggest that investors should buy equities for growth and bonds for income. But low rates and QE have turned the traditional mantra on its head. Investors are increasingly looking to equities to fulfil their income requirements. And as the global equity market becomes dominated by these income-seeking investors, companies will become increasingly sensitive to their requirements.

Textbooks also say that the equity market exists to bring together those who capital and those who require it. Equity investors provide the riskiest capital to a company. They give up security of return in order to participate in the future growth of the business. Again, that looks less appropriate in current capital markets. Rather than providing new capital to companies, equity investors now seem more interested in extracting existing capital through share buybacks or dividends.
Another basic premise of financial theory — that lower discount rates should put a higher value in future corporate cashflows — is also being questioned by present circumstances. Low interest rates should encourage companies to invest more for the future because shareholders will value the resultant cashflows more highly. It is partly why policymakers have now set rates so low. But, again, these theoretical transmission mechanisms do not seem to be working. For the past ten years, a rising equity risk premium (ERP) has negated the supposedly positive impact of lower interest rates upon equity valuations. The ERP has now risen so far that equities have become an income asset, so increasingly attracting investors who are more interested in the next dividend than funding a new mine, drug or microchip.

It's all about the distribution

This brings us to a basic observation: companies remain reluctant to expand because increasingly income-obsessed shareholders don't want them to. If anything, ultra-low interest rates have exacerbated this theme. Policymakers should take note.

In 2011, US companies spent $650 billion on share buybacks and dividends compared to $580 billion on capex. While this is supportive of share prices, it does not help other stakeholders who would presumably prefer the capital to be spent on new investments and jobs. In markets where shareholder requirements have a greater influence upon companies, the suspicion of capex and preference for distributions is evident. In Europe, those sectors that invest the most are given lower valuations and in the US, share buyback and dividend ETFs have outperformed handsomely in recent years. It seems that the market is sending clear signals to companies "if you want your shares to outperform then distribute, don't invest."

What does this mean for policymakers?

If policymakers really do want to encourage stronger economic growth (and especially higher employment) then we would suggest that they take a closer look at the equity market's part in driving corporate behaviour. Despite high profitability, strong balance sheets and ultra-low interest rates, any stock market observer can see daily evidence of why the listed sector is unlikely to kick-start a meaningful acceleration in the global economy. A recent Reuters headline says it all: "P&G Plans to Cut More Jobs, Repurchasing More Shares".

If anything, low interest rates are increasingly part of the problem rather than the solution. Perversely, they may be turning the world's largest companies into capital distributors rather than investors. Perhaps rates should be allowed to rise back to more natural levels. This might be painful at first, but it could stop equity investors being so income-obsessed. Or maybe the real problem here is depressed equity valuations. Low PEs and high dividend yields reflect the long slow death of the equity cult. At the margin, current valuations encourage CEOs to distribute through buybacks or dividends. They discourage capex and job creation. Perhaps instead of buying government bonds, the next round of freshly minted QE cash should be used to buy the stock market instead.

Alternatively, and more menacingly for equity markets, policymakers might use the tax system to clamp down on capital returns to shareholders. "Investors are forcing companies to over-distribute and under-invest" has a certain populist ring to it. This was exactly the argument used to justify the removal of the dividend tax credit for UK investors back in 1997. Another, more equity-friendly, policy might be to give greater tax breaks to capex.

Even if economic uncertainties and shareholder constraints mean that listed companies are unlikely to embark on a capex binge soon, maybe low rates can have a more textbook impact upon unlisted companies. Having no stock listing could make them less aware of investor pressures and more willing to adopt expansive strategies. Perhaps these are the companies that offer the best hope for a pick-up in employment.

What does this mean for investors?

If policymakers hope that listed companies can help drive down current high levels of unemployment then it could be a long wait. Corporate expansion plans are likely to remain constrained by uncertainties about the global economy and a shareholder base that is more interested in share buybacks and dividends than capex and job creation. But despite our misgivings about their effectiveness, interest rates are likely to remain very low for some time.

What are the implications for investors?

  • Equity markets are supported despite weak growth. Income-seeking capital should help to support global equities. Even if earnings growth is held back by weak economic growth, buybacks and accretive cash bids should help EPS expand.
  • Inflation may come back sooner than expected. Just as equity market funded over- investment during the Tech bubble created deflationary excess capacity, so perhaps under-investment may now be creating the potential for future inflation. Bond investors should take note.
  • Equity income and de-equitisation strategies are still key. Premium dividend yields relative to bonds should continue to attract income-seeking investors to the equity asset class. This will keep the appetite for equity income strategies strong. Those companies that offer progressive dividend policies should be rewarded with outperformance.
  • Smaller growth stocks can trade at premiums. Despite the current circumstances, equity financing is still best suited to fund longer-term growth projects. But the limited amount of capital available to sponsor these projects means that growth premiums are likely to remain focused in companies down the market cap scale.
  • Activism is here to stay. Expansionary strategies by corporates will continue to be treated with suspicion by the equity market and subsequent share price underperformance may attract the attention of activist shareholders. Those CEOs, particularly at the largest companies, who do not give this income-seeking market what it wants may find themselves replaced by a CEO who does.

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Death and Gravity's picture

Forced low interest rates is destroying a market; a way of exchanging financial capital for profit. Of course it won't work, it's like burning a bridge at the same time as trying to get heavily loaded trucks across it.

NotApplicable's picture

Malinvestment shouldn't be that hard of a thing to understand.

Yet the pyramid building will continue, unabated. At least until they run out of blocks.

The Shootist's picture

Of course it will. How else do you perpetrate a pyramid scheme?

Michaelwiseguy's picture

Me, the smartest guy in the room, on why QE isn't working;

You can't have job creation in the USA because the vast majority of factories that produce consumer products were removed from the country.

The Money Math for Job Creation doesn't work due to Globalization, Trade Treaties, and the Federal Reserve Corporation.

Bobbyrib's picture

Bingo. You are the smartest guy in the thread. QE isn't working not just because it encourages malinvestment, but also because the economy is a gutted shell of its former self. With consumer spending being 70% of the economy and the US consumer being broke thanks to corporate America's policies of outsourcing and insourcing (visas to push down wages). It's not hard to understand that broke consumers will not continue to fuel economic growth. Job growth is at an all time low, because the investment that the companies would have to put out doesn't have a good chance of being a good ROI (return on investment), so the CEO's participate in the Ponzi everyone loves to talk about on this site. Why invest in the economy when you can push up the price of your stock by having high dividend yields (making it attractive) and having stock buybacks? When it comes time for the executives to cash in on their stock options, they exercise and sell into the higher stock price. Citi should include this dipshit in the massive firing of the 11,000 they are about to purge.

Hey, maybe Citi is going to buy stock back, and issue a stronger dividend. /sarcasm for the moron who wrote this POS article.

Who the fuck is downvoting his post?

It must be the same morons who voted this as a 4 or 5 "star" article.

Michaelwiseguy's picture

Thanks Robbyrib, especially for pointing out 70% of our economy is consumer spending and other points. At least someone else understands the situation. 

I pretend those two sentences I wrote are not rocket science, but I think it must be, because no one in our entire economic decline discussion has been discussing this fact at all.

We can go back to Bi-Lateral Trade agreements as a proposal, to help get our country on the right track.


Next to Arch Stanton's picture

Since 2009 or so, I often wonder if the historic 70% consumption driven economy metric will no longer hold true.  I suspect with higher unemployment (chronic), boomer generation retiring (and with a lot less money than 10 years ago), and stagnant wage growth, there might be a new, lower consumption component to GDP measure.  After all, Govt spending is taking its place.

Any ideas what the consumption component was in the 1950s - 1970s?  I suspect that prior to the debt binge and outsourcing it was lower.  Besides deleveraging, our economy needs to retool to account for less consumption in the future.  Maybe we could make stuff again.  

Dingleberry's picture

Ultimately it's failure is due to inflation. It's like swimming against the tide or betting against the house. Eventually, you lose.

Interest-free money in an inflationary world does not bode well.  Recent case in point:  I just noticed my new tube of Arm & Hammer toothpaste that I normally buy felt "skinnier" somehow.  So I got the old tube from the trash and behold:  the new tube shrank from 7.2 ounces to 6 ounces.  About a 16% rate of inflation.  I could give other examples by the dozen, but there is no need.  You bitchez already know that.

Come up with any reason or excuse for the middle class being gutted.  There are all valid excuses.  But the REASON always comes back to the same thing: fiat-induced inflation.  QE just made it worse, and faster.  The consumer is getting hammered by inflation on the back and front ends.  Low financing costs are not helping because that benefit is being overwhelmed by the actual cost of living.  And will continue to do so.  

klockwerks's picture

So right Dingle, last bag of dog food, 35#, month later 30# and $11 more. Place is going to the dogs. I go nuts when I hear 2% inflation but see ALL packages getting smaller and higher priced. Really amazing and what a con

Bobbyrib's picture

I believe in the biflation theory. The sales on the crap we don't need this year is even better than last year's for the holiday season. Moving inventory must be getting harder and harder for corporations. I have a feeling profit margins are going to be low this year.

Unfortunatley they can raise prices, or reduce product for things we need like toothpaste and dog food.

Debt-Is-Not-Money's picture

"...but also because the economy is a gutted shell of its former self."


All of those who participated in the hollowing-out of this country are TERMITES! That's what a termite leaves behind, a gutted shell.

Then, in 2008 they exposed their hand and showed what a bitch debt is. Now, even when the banks want to lend noone wants to borrow! They can't get "money" into circulation to create the inflation they want. The best they can do is biflation and I don't know how long that can last as the velocity of money continues to plunge:

Bobbyrib's picture

Eventually they will succeed at the wrong time and hyperinflation will set in.

cougar_w's picture

Go to the head of the class.

batterycharged's picture

The rich have squeezed all they can out of everyone.

Everyone is tight with money now. Corporations have no reason to invest because again....the rich have already squeezed all they can.

It's an endless spiral. Any person that sees growth in this shithole economy needs a labotomy.

It's like a boa wrapped around you, each time you exhale its grip gets tighter. Companies sit on trillions in cash and yet they continue to look for cheap labor and tech solutions, while complaining about shrinking revenue.

Hey maybe all the poor in Mexico and Asia can be the new consumers....sure.

Bobbyrib's picture

That was original their plan. I think they are starting to see that it will not work.

TruthInSunshine's picture

Ya know, I was just wondering whether QE/TARP/TALF/TWIST/OTHER RADICAL INTERVENTIONISM has created a misallocation of capital that's so widespread and so enormous, that it may have created inevitable, extreme hazards risks for markets and the overall economy going forward...


(I really wasn't wondering whether this was the case. I know the answer, and I suspect the fractional reserve charlatans/mountebanks do, as well.)

booboo's picture

Well when all corporations are reduced to a front office staffed by 4 part time employees tasked with bringing coffe and blow jobs to the Board of Directors that in turn are tasked with issuing stock to Pension Funds that are tasked with keeping pension check rolling out to retired public employees that have hired their 80 year old not so fortunate neighbor to clean their dogs anal glands for two bits we will know for sure if it is working.....or not.

Until then, lets pretend it is because pretending is the new reality.

I walked into bar at 1 am about 30 years ago, the air was so thick with tension you could cut it. My friend dropped his drink, hit the floor with a crash and the entire bar exploded into a fist fight. We are almost there.

cougar_w's picture

Damn. I didn't even know dogs had anal glands. Had to look it up to make sure you weren't yanking our chain.

Now I'm wishing I hadn't. Yuck.

LMAOLORI's picture



Yes forced low interest rates are bad but bernanke does it so obama can keep spending bernanke wouldn't want him to say anything about the billions he is paying his member banks not to lend.  Savers and the elderly be damned!


Cure for Economic Slumps Seen in Raising Rates: Cutting Research

rbg81's picture

Rates will NEVER be allowed to go up.  The Government simply can't afford it.  It would immediately make the deficit unaffordable and cause the Entitlement State to collapse.  As you indicated, politicians don't care about the Economy--they want to dole out the $$ rather than business--it helps them keep the Power.  Bernake is only too happy to help.

The trend is your friend's picture

Citi just announced 11k layoffs which translates into more QE since Benny doesn't see a lower unemployment number in the near future.  One day it will be just a branch network to make depositors feel like their money is safe with a direct connection to the fed's computers and no other employees will be needed. 

Bobbyrib's picture

If you looked at the national debt before Obama took office and saw how much money we owed per tax paying citizen and how much in future entitlement obligations that are owed to people it was abundantly clear we had to monetize the debt.

lineskis's picture

Guess: just not enough? /sarc

Back to reading...

HelluvaEngineer's picture

We obviously need a bigger hammer.

nmewn's picture

No shit, shared sacrifice my ass.

Central Bankster's picture

Hilarious.  Japan has already tried this to the extreme.  Buying domestic bonds, equities, FX, and foreign bonds.  Everything under the god damn sun, and the more they buy the worse the real economy in Japan gets.  WHY?! Isn't it obvious, central planning and fascism DO NOT WORK.

fonzannoon's picture

" Perhaps rates should be allowed to rise back to more natural levels."

Lol. Go for it.

SpykerSpeed's picture

B..but Keynesianism was supposed to work!  Princeton and MIT told me so!  Everybody knows interest rates should only go down!

Cdad's picture

If anything, low interest rates are increasingly part of the problem rather than the solution. Perversely, they may be turning the world's largest companies into capital distributors rather than investors. 

From the category of "better late than never," I guess.  Good thing these Citi boys finally caught up to ZeroHedge.  The massive special dividend push going on right now is going to be absolutely devistating to stock valuations next year.  But Wall Street really only knows one thing...pulling the value of something forward and skimming it.

Hi ho.

Bobbyrib's picture

Who gives a shit about these companies' stock valuations? At that point it will be our turn to laugh..

Yellowhoard's picture

Does anyone have any idea what interest rates would be in the non bubble world of the Bernanke?

seek's picture

Purely speculating, but...

Gold says the rate of inflation the last couple years is about 9%, and historically low-risk returns (e.g. pension funds) have presumed something like a 5-8% real return.

So... 14-17%. Just like the last time this shit happened in the late 70's and Volker came in and fixed it by putting treasuries that high. (I remember people being delighted to get a mortgage at 14%!)

If that happened today it'd blow the government right up, but good.

Of course if real rates were that high, inflation would plunge and we'd probably see rates reach equilibrium closer to 6-7%. But right now, they should be in the mid teens.

mayhem_korner's picture



Good speculation.  I think the gubbmint would blow up if it got to 6%, but that's just me. 

Scratch that...the gubbmint is already blown up, the masses just haven't realized it yet.

seek's picture

I think even the most retarded economists accept that then debt service exceeds gov't revenue, you're officially 100% fucked.

With the current debt ($16T) and 15% interest, debt service is $2.4T. Receipts in 2011 were $2.3T.

At 6%, debt service is $1T. In theory there's enough revenues to cover that, though it means the budget would need to be $1.3T to balance (that'd be a 63% cut in spending, lol.)

So yeah, we're already completely fucked -- if we had a "real" economy and "real" interest rates, the government and USD would be dead right there.

It just hasn't registered yet thanks to their games and they keep printing to cover it up, but clearly the situation is unsolvable in its current form. A reset is the only way out.

mayhem_korner's picture



Eventually, we will find out.  Markets are like starfish.  A starfish uses suction to outlast the clam, who uses muscle to try to keep its shell closed.  Eventually the muscle tires and the starfish wins.  The market is the starfish and Benny is the clam.  His money-printing muscle will eventually yield and the default premiums will set in.

TruthInSunshine's picture

Bernanke's like the Easter Bunny, but a far more sinister version.

He's hidden price distortion hand grenades and land mines all over the place.

Happy hunting, Muppets!

Temporalist's picture

@mayhem   Bernankegles!  Bear down bitchez!

itstippy's picture

Damn that's funny. 

Every muppet's attractively-painted "nest eggs" could be the real deal, or they could be cleverly concealed price distortion hand grenades and land mines.  The little dears will either hatch or blow up. 

mayhem_korner's picture



Corporations don't behave to maximize profit; they behave to maximize stock price.  QE contributes a lot to decoupling profitability and stock price.  So the thought that QE will stimulate profit-maximizing behaviors is suppressed by the direct impact QE has on stock prices.  And so the strategy is to feed the levitation, not invest in the actual business.

QE is doing exactly what it should's just not doing what the knuckleheads think it ought to.

MFLTucson's picture

It is not working because you have the most unamerican president in American history working against the economy and to enslave the white American workers.

mayhem_korner's picture



That is offensive.  How you call such an upstanding Indonesian of Kenyan heritage "unamerican" is beyond me...

cougar_w's picture

Now that's just silly. American workers were being destroyed constantly over the last 30 years -- starting in the '80s -- by corporations exporting factory jobs to Asia and Mexico. Americans are now slaves of the welfare state certainly but that was long in the making and had nothing to do with any particular president.

RKDS's picture

You're a moron who thinks history began in January 2009.

g speed's picture

If low interest is causing malenvestment then that is policy-- after all this is a consumer driven local ( US) economy with priority on foreign policy and the world economic domination, and dividends and buybacks distribute to enhance consumerism as well as any other method.  

cougar_w's picture

End game.

This is how it works now. Large companies are awash in cash. Why? Because they have been cutting back on strategic investment and pulling forward customer commitments by offering deals that have zero margin just to get the sales numbers. Nor are they shy about one-time revenue boosts from sales of divisions, patents and assets. Since they are not innovating or pushing into new markets they can lay off line-level employees (except sales) and pocket the savings. Their stock tanks when they cannot meet sales or growth goals, but that's okay because they use part of the net net to buy their own stock, to make it look competitive in the market.

Smoke+mirrors people. They are just buying time because ...

... the global economy is blown. Toast. Nuked. Smoked. Burnt. Screwed. FUBAR (Fucked Up Beyond All Recognition for you youngsters out there). These companies buying their own stock see a 2-3 year timeline at the longest, beyond that is just a great big black sucking void of nothing-good-happened. If a miracle happens somehow and things tick up they can use their cash horde to quickly re-hire, or just as likely to buy up their weaker competitors who -- trying stupidly to you know run a business and retain good workers in hard times -- kept to the essentials of growth and innovation and ran themselves into Chapter 11. You need employees suddenly? You know where to get them, and you can kill another company in the process. Double-plus!

Only the robbers and theives are going to make out from here forward. The vulture LBO outfits like Bain will feed well indeed. Everyone else is expected to do the right thing; drive down to the reservour, leave a note saying how much you loved your family, and blow your own brains out.

Temporalist's picture

Truth!  And it's been going on since 2000.  This is just the continuation of same shit, different decade.

koaj's picture

lets break some windows...that should help next quarters GDP