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It's The `Early April Effect'


Economic Trends

IT'S THE `EARLY-APRIL EFFECT'

Late IRA savers boost the market

According to efficient-market theory, stock-market movements are essentially random. That is, prices show no predictable pattern from day to day or month to month, but instead instantly reflect only changes in fundamental information. Still, market observers are constantly looking for, and finding, "inefficiencies"--market trends, such as the so-called "January effect," that seem to persist over time.

Recently, economist Mike Farrell of Aeltus Investment Management Inc. turned up one such pattern that seems to have legs. Noting that the law creating individual retirement accounts went into effect 20 years ago, he figured the hordes of taxpayers rushing to fund or establish IRAs and similar accounts close to the Apr. 15 deadline would have a positive effect on the market.

Sure enough, Farrell found that the average annualized return in the first two weeks of April since 1978 was an impressive 20.7%. By contrast, the average return in the second two weeks of the month was only 13.6%, which is roughly equal to the 14% market return over the whole 20-year period.BY GENE KORETZReturn to top

A RISKY DEARTH OF DIVIDENDS

Who really benefits from buybacks?

Once upon a time, in the not-too-distant past, investors cared a lot about dividends. In that simpler era, dividends had a major influence on stock prices and long-term total market returns, and companies tried mightily to maintain and boost such payouts.

Flash forward to the booming 1990s, and it's clear that things have changed dramatically. The dividend yield on stocks--dividends as a percentage of share prices--has plunged to an all-time low of 1.4%, yet the market has doubled in the past three years, and investors keep funneling money into mutual funds. Meanwhile, companies are paying out record-low shares of earnings in the form of dividends (chart).

The conventional wisdom is that these trends reflect changing economic realities and investor preferences, so they're not really worrisome (BW-May 11). But Wall Street economic consultant Peter L. Bernstein isn't so sure. "It's time," he says, "to ask who really benefits from the downgrading of dividends--shareholders or managements?"

A new study by Christine Jolls of Harvard University's law school sheds light on the issue. Jolls examined the relationship between stock-buyback plans and stock options awarded to top execs. Most companies unveiling buyback plans say their goal is to raise stock prices by reducing shares outstanding, thus boosting per-share earnings. By using cash this way, they can provide shareholders with capital gains rather than more highly taxed dividends.

Jolls doesn't dispute this, but she points out that the tax advantage of capital gains is nothing new, whereas buybacks have boomed only in the past 15 years--just as stock options for top-level execs have taken off. Since these are the same folks who make the decision to adopt buyback plans--and such plans obviously benefit them by boosting stock prices--she wondered whether there was a connection.

Looking at 350 major companies in 1992, Jolls found a strong correlation between those implementing buybacks and those with a large number of outstanding executive options. By contrast, companies providing top execs with other forms of incentive payments were far less likely to implement buybacks. And Jolls found no relationship between buybacks and options for lower-level employees.

Of course, just because top management benefits from buybacks doesn't mean shareholders can't benefit as well. Indeed, options are supposed to focus management's efforts on promoting shareholder value.

The problem, Bernstein says, is that managements aren't simply replacing dividends with buybacks. As earnings have surged in recent years, companies have decided to forego dividend hikes, buyback programs or not. Moreover, the tax advantage from buybacks doesn't help people who invest in tax-sheltered pension accounts or in mutual funds that throw off short-term capital gains that are subject to ordinary income-tax rates.

By hanging on to an outsize share of earnings, Bernstein argues, managements are making reinvestment decisions that should be made by the free market--that is, by stockholders who might choose to invest in other companies. They are also exposing investors to more risk, since returns become more dependent on uncertain capital appreciation and less on cash flow from relatively reliable dividend streams.

In fact, Bernstein's own research indicates that low dividend-payout ratios historically have been, and continue to be, a strong predictor of weak future earnings growth--including the slowdown that is now under way.BY GENE KORETZReturn to top


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