|Buybacks Have Created A Dangerous Illusion (click here)|
To be perfectly clear, buybacks are a tool corporate boards and CEOs use to manipulate the prices of their own shares higher. This means insiders can get out or hedge their positions before reality sets in and prices fall back to earth. Call it a well constructed exit strategy if you like. This is where I remind you it is major investors that sit on the board or hold executive positions and the same CEOs and other top managers who have received much of their compensation over the years in stock options. Yes, these are often the shareholders in the company that have reaped the largest benefits of QE over the years and added to inequality.
|Buybacks Have A Darkside And Drive Inequality|
Several unusual currents are running through the market right now, one of those is low volatility of which share buybacks are a major contributor. This is because buybacks are insensitive to price and simply steps in and are ready to purchase on any weakness. With this in mind. it is important to remember that much of the buyback action over the last several years prior to the Trump’s tax changes has been financed from debt raised by selling corporate bonds. This means many companies will not have the money to keep their stock flying when the market begins to fall and leveraged companies will get hammered. These most likely are not the companies with cash stockpiles overseas that can now be repatriated cheaply and to make matter worse they now face higher interest rates.
Buybacks are why we have been hearing so many analysts touting the line that stocks are not overvalued and how earnings are growing. What they are referring to is earnings per share, and what is really doing better in that fraction is the denominator. Records show U.S. firms have spent roughly $4 trillion on buybacks since 2009, this means corporations have been the biggest single source of demand for U.S. shares during the so-called recovery. It is reported by 13D Research that buybacks have “accounted for more than 40% of the total earnings-per-share growth since 2009, and an astounding +72% of the earnings growth since 2012. Simply put, many corporate boards have made the decision to drain the company coffers in order to buy back shares, often from themselves and sometimes even in special deals offered only to themselves off the general market.
This is why according to an IMF estimate from last spring that large U.S. corporations have experienced a negative net equity issuance of $3 trillion since 2009. Linked to these share buybacks we have seen U.S. corporate debt to soar to an all-time high of $13.7 trillion. Companies are not investing this money because the demand for new production simply does not exist, sure a few upgrades are in order but that is already figured into business on a year by year basis. Also, little reason exists to buy a competitor or attempt a takeover while stock prices are so high.
Instead what we have seen and continue to see is that companies are plowing money into stock buybacks. All this reinforces what I and many others thought regarding the strong tilt of Trump's tax bill towards rewarding America's wealthy. The bill was not about tax reform and will only add to the trend of growing inequality. The fact is Trump's tax reform has prompted a surge in buybacks courtesy of offshore cash repatriation. It is estimated this will boost EPS growth by more than twice what U.S. economic growth would do. This, of course, does little in the way of creating real economic growth. Tomorrow in part two of this series titled; "Stock Buybacks Driving Market - Where It Might Take Us!" I will put forth some ideas on where this stock buyback mania will eventually end.