Bob’s Journal for 5/18/23

Investor Returns Depend on Stock Buybacks

Corporations repurchasing their own stock are a major factor in the markets and have been an important component of investment returns the last few decades.

Since 1997, buybacks have exceeded cash dividends. They’re the dominant way businesses pay profits to investors, according to a recent study from S&P Dow Jones Indices.

The study examined the hypothetical results of what the authors call “buyback portfolios.” These are indexes of the 100 companies in the S&P 500 with the highest buyback ratios in the previous 12 months. The authors compared different portfolios, such as those with the stocks equally weighted and those with the stocks capitalization-weighted.

Over time, the buyback portfolios generated higher returns than the regular stock indexes. The higher returns were consistent whether the portfolios were overweighed to large-, mid-, or small-cap stocks or had no such overweighting.

In addition, the buyback portfolios had higher excess returns in down markets than in up markets.

The buyback portfolios also outperformed dividend stock portfolios. Of course, most of the returns from the buyback portfolios came from capital gains, not dividends. The buyback portfolios did better in both up and down markets than the dividend portfolios.

The researchers found that equal-weighting stocks in the portfolios significantly improved returns in up markets, though the advantage of equal weighting was more significant in large-cap stocks than in stocks with lower capitalizations.

All stock investors should take heed of these findings, because corporate repurchases are declining. There’s less cash available for buybacks because of higher interest rates, higher labor costs, increases in other costs, and other factors.

Buybacks are likely to continue below recent levels for several years. That’s an additional factor that I believe makes stocks more risky today than they’ve been for some time.

Office Building Market Continues to Struggle

While most of the economy has recovered from the pandemic recession, office buildings have not.

Office buildings were dealing with some issues before the pandemic. Businesses were streamlining and looking for ways to reduce costs. The amount of office space per worker was declining, and a growing percentage of the work force was able to work outside the office at least part of the time.

The pandemic accelerated and amplified those trends.

In late 2022 and early 2023 many businesses were ending or reducing remote work. “Return to the office” orders were issued. Some companies said employees needed to be in the office five days a week, while others required only two or three days in the office.

At the start of 2022, the percentage of offices that were occupied during the work week exceeded 50% for the first time since the pandemic, according to Kastle Systems as reported in The Wall Street Journal.

But office occupancy seems to have reached a plateau at just over 50%.

The percentage of companies requiring employees to be in the office five days a week declined to 42% recently from 49% three months ago. Employees are allowed to work remotely at 58% of companies.

There are widespread repercussions from lower office occupancy.

Values of office buildings are declining. That means lower tax revenue for local governments. Fewer workers in offices reduces revenues of neighboring businesses, such as restaurants and bars.

Of course, the trends also affect office building owners and investors.

In April, Brookfield Corp., a major owner of office buildings, defaulted on more than $161 million in debt on a dozen office buildings. Most of the buildings are in Washington, D.C.

Brookfield already defaulted on debt tied to two large office buildings in Los Angeles. PIMCO, through its subsidiary Columbia Property Trust, defaulted on debt related to office buildings.

Other office building owners are selling their properties at low prices, betting that the decline in values isn’t going to turn around any time soon.

Several office building owners recently sold buildings for 20% or less than they paid for them less than 10 years ago, according to The Wall Street Journal.

Higher interest rates add to the problems. If a loan needs to be refinanced, the owner must pay a higher interest rate than a few years ago. Potential buyers factor higher interest rates into the prices they are willing to pay.

During economic downturns, office building owners usually work out deals with their lenders. Neither side wants to force the sale of a building in a distressed market. That’s why there weren’t many office building debt defaults during the financial crisis.

The recent defaults and distress sales indicate we are in a different period. Building owners appear to believe the market won’t turn around and want to get out now.

Well-capitalized investors, however, are seeing opportunities to buy buildings for less than their replacement cost and rent them profitably at rates much lower than those charged before the pandemic.

Midyear IRA Planning Opportunities to Consider

Tax return season is over, but there are tax-saving opportunities to consider between now and the end of the year. Here are a few IRA strategies to review.

Qualified charitable distributions (QCDs). If you’re over age 70½, have a traditional IRA, and make charitable contributions, you probably should be making those charitable contributions using QCDs.

You direct the IRA custodian to distribute the money to a charity (or you write a check against the IRA to the charity). The distribution isn’t included in your gross income, but it counts toward your required minimum distribution (RMD) for the year, if you have one. More details are in the April 2022 issue of Retirement Watch.

Conversions to Roth IRAs. I explained in some detail in the March and April 2023 issues why many people should consider reducing their traditional IRAs and 401(k)s in the next few years. A good way to do this is to convert all or part of a traditional IRA into a Roth IRA. Review the issues and see if a conversion is a good idea for you.

Backdoor Roth conversions. Some people want to make contributions to Roth IRAs, but their incomes are too high. They aren’t eligible to make Roth IRA contributions. But they are eligible to make nondeductible contributions to traditional IRAs.

A good strategy is to make a nondeductible contribution to a traditional IRA and then convert that amount to a Roth IRA. Remember IRA contributions now are allowed at any age, but you must have earned income at least equal to the contribution.

You probably will owe taxes on the conversion unless you had no previous traditional IRA balance or had a basis in the IRA (meaning you made after-tax contributions in the past).

Required minimum distributions. Don’t forget to take RMDs before the end of the year. You can take an RMD in property instead of selling an investment and distributing cash.

People who inherited IRAs after 2019 generally need to take RMDs and must empty the IRAs within 10 years. The rules vary. Review the May 2022 and June 2022 issues of Retirement Watch for details.

Review beneficiary designations. The beneficiary designation on file with the IRA custodian determines who will inherit the IRA. If it has been a while since you looked at the designation or there has been a major change in your family, it’s time to review the designation.

If a trust is the beneficiary, have an estate planner review the situation. The SECURE Act in 2019 changed the rules for trusts that are IRA beneficiaries. You might want to change the designation.

The Data

Retail sales increased 0.4% in April after declining 0.7% in March. Over 12 months, sales increased 1.6%, which is down from 2.4% at the end of March.

Excluding gas and autos, retail sales rose 0.6% in April compared to a decline of .5% in March.

The Producer Price Index (PPI) increased 0.2% in April after declining 0.4% in March. Over 12 months, the PPI is up 2.3%, compared to 2.7% at the end of March.

The core PPI, excluding food and energy, increased 0.2% in April after being unchanged in March. Over 12 months, the core PPI increased 3.2% through April, down from 3.4% through March.

The Empire State Manufacturing Index tumbled to negative 31.8 in May from 10.8 in April. The May level is the lowest in four months and the second-lowest mark since July 2022.

The jump in the index from negative 24.6 in March to positive 10.8 in April appears to be an anomaly. The index has been in negative territory five of the last six months and eight of the last 10 months.

Industrial production increased 0.5% in April after being unchanged in March. Over 12 months, production increased 0.2%, up from 0.1% at the end of March.

Manufacturing production climbed 1% in April, compared to negative 0.8% in March. Over 12 months, manufacturing production fell 0.9%.

The Consumer Sentiment Index from the University of Michigan slid to 57.7 through mid-May, down from 63.5 at the end of April. That’s a six-month low for the index. There were declines in sentiment about both current conditions and the future, with consumers expressing concerns about the economy.

The Housing Market Index from NAHB increased to 50 in May from 45 in April. That’s the highest level since July and the fifth consecutive month the index was higher than the previous month.

The home builders say there is strong demand for new housing and limited supply. But they say shortages of supplies and labor make it difficult to meet the demand.

Housing starts increased 2.2% in April after declining 4.5% in March.

New unemployment claims increased by 22,000 to 264,000 in the latest week. That’s the highest level since October 2021.

Continuing claims, which lag a week behind new claims, increased to 1.813 million from 1.801 million.

The Markets

The S&P 500 lost 0.54% for the week ended with Tuesday’s close. The Dow Jones Industrial Average fell 1.61%. The Russell 2000 declined 0.72%. The All-Country World Index (excluding U.S. stocks) decreased 0.80%. Emerging market equities retreated 0.49%.

Long-term treasuries fell 0.16% for the week. Investment-grade bonds lost 0.48%. Treasury Inflation-Protected Securities (TIPS) decreased 0.22%. High-yield bonds retreated 0.65%.

In the currency arena, the U.S. dollar rose 1.08%.

Energy-based commodities declined 2.35%. Broader-based commodities lost 2.67%. Gold fell 2.15%.

Bob’s News & Updates

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A recent five-star review of my book, “The New Rules of Retirement” on Amazon.com said, “A complete retirement guide! One of the best books on this topic!” Click for more details about the revised edition of “The New Rules of Retirement.”

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