The "Greatest Rotation": From Capex To Dividends

Tyler Durden's picture

The latest Q2 US Flow of Funds data revealed that the corporate financing surplus declined to zero, for the first time since the Lehman crisis. The financing surplus is a measure of corporate savings, and in principle the lower this financing surplus the more expansionary the corporate sector is. Typically the corporate sector is dis-saving, i.e. capex typically exceeds cash flows from operations. However, the sharp decline in the US corporate surplus is less positive than it appears at first glance because it was driven by a rise in dividend payments rather than a rise in capex. As we have pointed out time and again, with the Fed's ZIRP, the only thing that matters is the share price and with firms increasingly focused on dividends rather than capex, to the extent that it continues, points to lower productivity and potential growth going forward.

In other words - as we warned 18 months ago,

the most insidious way in which the Fed's ZIRP policy is now bleeding not only the middle class dry, is forcing companies to reallocate cash in ways that benefit corporate shareholders at the present, at the expense of investing prudently for growth 2 or 3 years down the road.

We have discussed this previously:

No Record Profits For Old Assets: Jim Montier On Unsustainable Parabolic Margin Expansion For Dummies

 

How The Fed's Visible Hand Is Forcing Corporate Cash Mismanagement

 

Will CapEx Come Back?

 

Spot The CapEx Rebound (And/Or Growing Economy)

- and it's not getting any better

Via JPMorgan,

The latest release of US Flow of Funds for the second quarter of 2013 revealed that the corporate financing surplus, i.e. the gap between available cash flows from operations (net of taxes and dividends) minus capex declined to zero for the first time since the Lehman crisis (Figure 1). The financing surplus is a measure of corporate savings, and in principle the lower this financing surplus the more expansionary the corporate sector is.

 

Typically the corporate sector is dis-saving, i.e. capex typically exceeds cash flows from operations. Since 1952, when US Flow of Funds data begin, it has been only during US economic recessions when this financing surplus was positive. So although a decline in the corporate surplus to zero is an encouraging sign, its level remains above the typical negative levels seen during mid phases of economic expansions.

 

Also it remains to be seen whether the US surplus decline will be followed by the rest of G4 countries which are set to release Q2 Flow of Funds by the end of this month. As shown in Figure 1, the corporate financing surplus for the whole of the G4 had been rising during 2012 up until the first quarter of this year.

 

What drove the decline in the US corporate surplus to zero?

 

 

Figure 2 shows that this decline was driven by a fall in available cash flows, i.e. undistributed profits net of taxes. Capex increased only marginally in Q2. In turn, the decline in available cash flows was caused by a sharp rise in dividend payments in Q2. Dividends payments jumped to a record high of $163bn in Q2, 35% above the pace of the previous four quarters. Relative to nominal GDP, dividend payments returned to the record highs last seen at the end of 2006.

 

We see two implications from the above flows:

 

1) the sharp decline in the US corporate surplus is less positive as it appears at first glance because it is driven by a rise in dividend payments rather than a rise in capex, and

 

2) these flows reinforce a long term shift of the US corporate sector away from capex towards dividends. Figure 3 shows this long term trend over time.

 

 

Dividends have started rising vs. capex since early 1980s. The Q2 reading matches the record high seen in 2004. A focus on dividends rather than capex, to the extent that it continues, points to lower productivity and potential growth going forward.

This latest update from JPMorgan merely confirms what we foresaw,

The conclusion of all this is quite simple: the longer the "recovery" continues, without an actual recovery being coincident, and all is merely a game of optics and smoke and mirrors, corporate margins will start collapsing in a toxic spiral, whereby companies generate less cash, and have less cash to spend on CapEx, etc, until the next sector needing a Fed bailout is the corporate one, all the while the Fed's forced misallocation of resources forces companies to expend every available penny into dividend payouts.

 

...

 

Not accounting for accumulating and rising depreciation, or as we said, "we get back to what we have dubbed the primary cause of all of modern capitalism's problems: a dilapidated, aging, increasingly less cash flow generating asset base! Because absent massive Capital Expenditure reinvestment, the existing asset base has been amortized to the point of no return, and beyond.

 

The problem is that as David Rosenberg pointed out earlier, companies are now forced to spend the bulk of their cash on dividend payouts, courtesy of ZIRP which has collapsed interest income.

 

It also means far, far less cash for CapEx spending. Which ultimately means a plunging profit margin due to decrepit assets no longer performing at their peak levels, and in many cases far worse.

Reiterating what we said above, the most insidious way in which the Fed's ZIRP policy is now bleeding not only the middle class dry, is forcing companies to reallocate cash in ways that benefit corporate shareholders at the present, at the expense of investing prudently for growth 2 or 3 years down the road.