Where The Levered Corporate "Cash On The Sidelines" Is Truly Going

Tyler Durden's picture

We have long been pounding the table on what in our view is the biggest detriment to any future growth for not only corporate America, but the entire US (where, sadly, government investment IRRs just happen to be negative - a fact that most won't understand until it is too late, especially not self-anointed economic wisemen whose only solution to everything is "do more of the same" yet who thought the utility of the Internet would be eclipsed by that of the fax machine): the complete lack of capital expenditures at the corporate level, and lack of (re)investment spending.

This was explained extensively previously here, and even the WSJ finally caught on to what is the most disturbing trend over the past "New Normal" 4 years. What was also explained, is that instead of investing in CapEx and hiring, or said otherwise, real sustainable future growth coupled with benefits for workers and consumers, companies have little choice but to pursue shareholder gratifying, short-term IRR boosting "projects" like M&A, dividends and buybacks, or else feel the wrath of scorned shareholders who will simply dump said prudent company's stock and move on to the next company which is more generous with its declining cash flows, and puts shareholders above all.

This is summarized simply on the chart below.

It turns out that, however, that there is more to the story, and as the following chart from SocGen's Albert Edwards shows, not only are companies using up what actual free cash flows they have for such stupid stock boosting gimmicks such as harebrained M&A (just look at the recent fiasco between HP and Autonomy to see how rushed M&A always ends), and of course buybacks, but they are now levering to the hilt to do even more of this. Think Spanish and Italian banks using repoed ECB "equity" to buy back not only their but their sovereign's bonds. The last time they did this? The golden days of the credit bubble.

The chart above also shows the rise in bank lending in recent months: it is not going to retail borrowers for such trivial Uses of Proceeds as buying houses. It is going almost exclusively to IG and high-HY rated companies to pursue buybacks.

This is how Albert Edwards sees the problem in a note relased today:

The charts below show the source of this recent recovery in bank lending to the private sector. It is clear that loans to the industrial and commercial sectors (dotted line) have been the key swing factor over the last two years for driving overall bank lending.


It is also notable, looking at a longer term chart, how small bank lending to the industrial and commercial sector is relative to the real estate related and consumer category, the former being some 3x larger. Yet despite the moribund lending activity to the real estate and consumer lending, the total aggregate lending data looks healthy as a cyclical recovery in corporate borrowing drives the aggregate data higher (see left-hand chart below).


But what are companies doing with this extra borrowing? They certainly don?t seem to be spending it on investment, which has been plunging.


And therein lies the rub: neither organic cash flow, nor incremental net debt issuance (not gross, as the balance merely goes to roll over maturing debt and to refinance the capital structure into a cheaper cost of debt) is being used for "invesment, which has been plunging." It is instead being used to fill the void created by Bernanke's ZIRP, now that equities have to be the new debt and provide the return to investors once obtained from fixed income.

So while we have beaten this particular dead horse to death many times, here it is straight from another horse's mouth, how in not so many words, Ben Bernanke's policies are actively destroying America's Corporate capital base, and are setting the stage for an epic collapse in Return on Assets, if not so much Return on Equities in the CapEx-free years to come:

So on this data the corporate sector is borrowing heavily, both in the markets and from the banking sector, to suck up their own stock at a 4% annual rate ?albeit not as heavily as in 2007 or 1987. So to that extent, Helicopter Ben?s approach of printing money to drive asset prices up actually seems to be working! Newly printed money is clearly finding its way into the hands of willing corporate buyers of equity via the banking sector.


Putting aside for one moment just how lunatic a policy this is (already tried and tested between 2001 and 2006), we think corporates borrowing by the bucketful to buy in their own equity will end badly -? it always does! I finish this note with an insightful, more bottom-up analysis of this practice from my Quant colleague Andrew Lapthorne.


Andrew wrote, ?Of course, there are some perfectly sensible reasons put forward by corporate financiers for swapping today?s expensive equity (i.e. cheap from an investor?s point of view) for cheap debt (record low yields), especially given the ability of many corporates to issue 20+ year bonds plus the incentive that interest payments currently remain tax deductible.


We know that buybacks are contrarian indicators, occurring at the top (and not the bottom) of the market. Why, we ask, are companies leveraging up now and not 12 months ago, when equity prices were much lower? We conclude that (contrary to what we read), US dividend payments are not enjoying a revival relative to cash flows and that buybacks remain the distribution channel of choice for corporates wishing to boost EPS and limit the effects of option dilution. Indeed, some of the biggest US names have issued debt to pay for buybacks (Home Depot, Microsoft, Amgen, Hewlett Packard, McDonalds, DirectTV, to name but a few) but there are also firms in Europe that have been doing the same (Siemens, Telenet, Adecco). In the current economic climate, you may find this surprising ? we do too! A buyback in this form is not a return to shareholders ? it?s called gearing or balance sheet risk and will come to haunt some firms when the economy enters a downswing.


Andrew shows just how awful the timing of companies buying in their own equity has been historically. Often the corporate sector ends up as the only major buyer of stock near the peak of the market and then switches to issuing as the market crashes. This inevitably has exacerbated the equity boom and bust in recent years. And as pension funds now cannot tolerate the 50% plus draw-downs of the last decade, it can also be said that this corporate finance zaitech has contributed to the death of the cult of the equity, where equities once totally dominated the portfolio of most pension funds.


But can this time around be different? I seriously doubt it. When the next leg in the ?structural bear market? occurs, expect the equity buybacks to end, contributing to a renewed steep downturn in bank borrowing and monetary aggregates. The recent surge in the money data should be seen as a sign of the ills in the US economy, not health!

We could not have said it better.

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Titus Flavius Caesar Vespasianus Augustus's picture

So you're saying there's still a chance the economy will improvenate?

Mr Lennon Hendrix's picture

We're saying it's a shitshow.

Corporate or government, it's a total shitshow.

The corporations suck ass and lie, cheat and steal, need money, then the government, which also lies, cheats, and steals, threatens the end of the world as we know it unless the people give up their wealth to the corporations that sucked ass.

Total fucking shitshow all the way down the toilet.

Big Slick's picture

The timelag in difference between S&P index and corporate buyback plots is interesting.  I've heard some argue (like Biderman) that these buybacks are largely driving the market.  If so, why does the market peak prior to buybacks peaking?

I realize there are vast and complex forces at play here, but still... 

camaro68ss's picture

god this is going to be a shit show when this all unwinds. Lord help us all.

walküre's picture

It will surprise many. Was talking to some Germans the other night. I thought with their first hand exposure to the sad reality of a manipulated currency and fractional reserve lending, they would see the light by now. Nope. They still blame Greece, their alleged unwillingness to "reform" and the real estate bubble in Spain. They cannot comprehend that unemployment isn't a Greek or Spanish curse or that too many public service sector employees and their pensions or other entitlements will bring Germany to its knees as well. They're not even willing to consider that the German powerhouse economy is going to slide into recession, let alone a severe depression. I gave up trying to get my points across.

AldousHuxley's picture

Germans save like Jews after experiencing loss at two world wars (reparations to pay for winners). However, the country is still in debt. because average germans have no control on large enterprises nor government spending.

That's because debt = leverage...bet on a boom. when boom goest bust, workers pay for misplaced bets by politicians and corporate titans.


basically leaders around the world suck at being leaders and have shown that they have zero legitemacy.

HungryPorkChop's picture

Here's a 5 minute that sums up Greece.  It's hilarious!


Manthong's picture

In case anyone has been wondering, all the CapEx has gone to China. 

Titus Flavius Caesar Vespasianus Augustus's picture

Dude, don't worry.  Obama is gonna set you up nice in one of the Hope Camps.   You'll probably have to do lots of reading to correct your BadThink, but that's a small price to pay to create Hopetopia.


Once DHS gets rid of all those Firsters  {those who think the 1st Amendment exists} the rest of us will simply get our chips and stop having to worry about anything anymore except contemplating the glory and power of our Dear Leader.


Big Slick's picture

Another telling thing about that very powerful first graph is dissuasion of the notion that corporate 'insiders' are sophisticated market participants.  I thought the idea is to "buy low, sell high." Not the other way around. (I read that in a book somewhere)

AldousHuxley's picture

consistent way to beat the market (pricing determined by millions of investors) is to trade on inside information.



blunderdog's picture

The corporate insiders may well be SELLING the shares that are being bought back.

archon's picture

I think of it as a risk-transference engine...  buying one's own equity is trasferring risk from shareholders to the firm's management.  Fewer external stakeholders means less external accoutnability.  The difference between buying one's own debt and buying one's own equity is merely a matter of perspective - on the one hand you write yourself an iou, on the other you write yourself a u-o-me.

Larry Dallas's picture

I can't think of any companies off hand that have completed any of their buyback programs as announced. Not in the past 10 years.

This is the oldest trick in the book. Short term pop, then forgotton about tomorrow.


kliguy38's picture

Its all to maintain CONtrolfidence

Winston Churchill's picture

Suffocate under the blanket of mal investment.

Not only is the Govt. pushing on a string ,now the corporate sector is as well.

This going to end so well,that it will make the Great Depression look like a Bake sale.



bagehot99's picture

What does Obama's leading troll MIllion Dollar Bonus have to say about any of this, or has he, ahem, fucked off?

Its_the_economy_stupid's picture

I think MDB is just playing w the crew. it's all tongue in cheek.

davinci7_gis's picture

THE FED is buying $45Billion a month in MBS and the economy is still not going anywhere!

Cognitive Dissonance's picture

More of the same (insanity) always seems to work.............until it doesn't.

<Clean up on aisle three.>

LawsofPhysics's picture

Even more insider "circle jerking" by those entitled stanford and harvard business school graduates? So, the capital and resource mal-investment and mis-management continues.

Again, color me "shocked".

augustus caesar's picture

I agree that it's a circle jerk, but this was never intended to be investment or capital building in any way ... it's an escape pod, they're buying back stock with taxpayer borrowed money so that the insiders can cash out leaving the taxpayers and pensioners holding the bag.

RockyRacoon's picture

It appears you may have struck upon the Universal Corporate Truth.  I'd keep an eye out for black SUVs pulling up in your driveway.  Got lead?

Silver Garbage Man's picture

The GREAT PONZI is coming to an end.I hope you are ready.

inevitablecollapse's picture

when?  i do believe that things are 'shittier' than normal, but does anyone have a prognostication on a range of time?  i see a lot of folks that are adamant that it will be ending, but not a lot of discussion centered around when?  is collapse inevitable in 6 mos, 12 mos 5 years?  not necessarily directed at you SGM, but a general question to anyone that has thought this out and has timing in mind?  what will send this entire shit-show into hyperdrive?

camaro68ss's picture

for 50 million americans in poverty, its already happend

Silver Garbage Man's picture

If I told you your house was going to blow up sometime between now and 5 years from now, when would you leave?

inevitablecollapse's picture

good point, though there is parallel risk in everything we're involved in.  if i told you that there was a 100% chance you would die, when would you give up on life?

ParkAveFlasher's picture

You would give up on life every moment you remain in the house.

Silver Garbage Man's picture

I'm not giving up on life, I'm giving up on fiat,fraud and corruption.....the rigged casino.

Silver Garbage Man's picture

I'm not giving up on life, I'm giving up on fiat,fraud and corruption.....the rigged casino.I'm getting back to life.

brettd's picture

Just my house or the whole neighborhood? City? State?

Depends on where I could go that won't explode....

brettd's picture

Just my house or the whole neighborhood? City? State?

Depends on where I could go that won't explode....

SMG's picture

My best guess, cause a defaltionary depression next year (pick up real assets by the Elite on the cheap one last time), lasting as long as 6-8 months before the next election in 2014.  At that point, start the hyperinflation which will temporarily boost sentiment and reelect the status quo in 2014.  After that election, dollar collapse and hyperinflation.

By then the depopulating nuclear/WMD WWIII will be set up and could start anytime within the next 4-8 years.

After that the Elite rise from their bunkers and offer us whatever is coming next.

Just my opinion.

Good luck I hope we all make it to the other side.  What a time to be alive.



inevitablecollapse's picture

thanks for this - i really just wanted to get some feedback on sentiment, appreciate your response.  i don't believe there's an empirical way of determining the when, which for me is the most difficult part.  i do think that there will be some 'surprises' along the way...

Invisible Hand's picture

When is obviously the key but impossible to know.

As Yogi said:  "Forecasts are hard, especially about the future."

The difficulty with complex systems (like the economy) is that they do not change gradually (for the big changes) they change in a stepwise fashion.

Most people will continue to have faith in fiat until critical mass of opinion is reached and suddenly no one (outside of the professional liar class--politicians and their tame media) will want fiat.  Buy PM's now before everyone wants to but no one can. 

Caveat:  The government will confiscate PM's immediately after the crash and they will be illegal to own for a half century, or until the government collapses, whichever come first so how much protection are they?

Collapse of the financial system will probably be intiated by major sovereign defaults (Europe or Japan are most likely).  This will be followed by derivatives blowing up all major financial firms.  Kyle Bass says he doesn't know when Japan will go, so I certainly wouldn't guess.

What do you do to protect yourself from this?  Again, buy PM's, land and commodities.  Can you retain title to any of these things after the collapse.  Who knows but I doubt it?

I don't see anyway to protect yourself and your family in the coming years, except maybe going all survivorish way off the grid and we're too old and sick to do that.  Not sure even that will work.

Have a nice Thangsgiving!

jumbo maverick's picture

Pertaining to title of lands I could see the following take place but you would have to have out of the box thinking people to accomplish it-

I live for the most part in a geographically large rural county. There is not much money here and business/employment is weak but there is an awful lot of land. Much of it valuable farm land.

My county commissioners, sheriff and the coroner could draw up plans for an immenant collapse, a collapse which I think is unavoidable. They could use some kind of reasonable criteria, as an example if the federal government officially states the economy is in a depression, or if official unemployment for the country rises above 10percent. This would take reasonable people making reasonable decisions.

Once the criteria is met then title to your home or property is turned over to you even if you still owe money to a bank. I agree with rule of law. I agree with contractual law as well. Here in lies the problem, see the way I figure it is that the banks were already paid for all the property within the united states by way of programs such as TARP, QE1, QE2, QE to infinity.i and my family will pay the rest of my life to the banks for these programs and on top of that I will still make my monthly mortgage payment. My son who ain't even of working age will pay for these programs till the day he dies too. So no matter what you or anyone else says I've already paid.

When the bank people come calling the sheriff can just say to them, nope everybody in this county is done from here on out. Its hands off and you won't get nothing. Nobody is being evicted, in fact all the property has been turned over to the people living in the homes.

When and if members of th federal government come to assist the bank people the sheriff can tell the, get out and don't come back. The whole fucking county has been deputized. Everybody is armed. Go somewhere else you won't get anything from us.

Again I would have been happy just paying my mortgage but the government and the banks did a dirty trick by making the regular guy like me double pay. I pay for my own home and now I'm also paying for all this other horseshit on top of it so they can just fuck off.

brettd's picture

Think more like a python than an earthquake.  It's not like the movies.

Medium sized "hits" to the economy, that give politicians a chance to "fix" things.

ie:  big downswing in market. Retirees scream bloody murder.

govt solution:  "for those 55 and over we'll restore your IRA to it's pre-hit level...but with patriotic, tax exempt government bonds...."

After that, there will be another.  

Perhaps a spike in youth unemployment:  

So, government says, "Student loan forgiveness via government "work".



walküre's picture

The deflationary depression happened in 2008. We're well into the hyperinflation scenario.

The CBs have to print massively at this stage. If we deflate from here, the elite and their fairy tale governments are toast.

Relentless's picture

I dunno about nukes flying, but I've always considered that this winter is going to be the point it all becomes unhinged.


The US could probably keep the can kicking and monetising working for quite a while yet if it wasn't for Europe. The ECB is is sitting on top of a pressure cooking full of boiling turds. They keep ratching down the clamps, but they can't turn off the heat. At some point during the next couple of months either Greece or Spain is going to reach the point of not paying anything because they don't have the money and then its going to unwind fast and everyone is going to be wiping shit off of their faces. The financial crisis will take everyone down. There won't be global war because no one can afford it, but they will deperately try to blind everyone to the existence of the crisis with either a new super deadly flu scare in Jan/Feb or quietly egging on all the sides in the ME for local conflicts that don't actually cost the US much but which absorb all of the media bandwidth.


Unless of course some Mayan nutters have managed to take control in the government and are actively trying to make everything go pear shaped in December....


Remember Germany didn't do to war during its econmic troubles, it went to war after it had recovered from them.


Nobody For President's picture

Plus one for 'a pressure cooker full of boiling turds' ...

brettd's picture

Their "recovery" was driven by re-militarization....

stockscooter's picture

My contention, for some time now, has been that we may see something that has never happened before–Deflation with rising interest rates.  The deflation stems from the continued credit contraction and derivatives melt-down.  Rising rates will not come form rising food costs through the commodity markets as some suspect. But it will come from the downgrading of the U.S. Treasury Bond.  We’ve already seen if fall from AAA to AA by the S&P rating agency, over a year ago.  Finances are worse for the U.S. today then back then.  Election year politics have prevented another downgrade.  But mark my words, another one is coming. Our national deficit has grown larger than our annual GDP!  The downgrade in credit worthiness will push rates up as buyers of our debt will demand higher returns for the increased risk.  No one is talking about this, yet it seems obvious...


Big Slick's picture

Precise timing is impossible.  Less likely than a rapid catastrophic collapse, is a slow motion implosion.  Like being locked in a refrigerator that is tumbling down a long stairway to hell.

"when she gets there she knows..."

inevitablecollapse's picture

i too have a feeling that this is going to be a more gradual degradation over time - quality of life will decrease, more 'uneasiness' being felt, etc. etc. of course, there could be a catalyst to set this whole thing aflame, but i would anticipate a gradual decent into oblivion

reload's picture

My take too, the attempts to `fix` the monetary system are designed to fail. But many still believe that it is just a matter of time until the world goes back to 1995 or 2005 -because this is the mantra the media are following. Unfortunately for us all, life is going to slowly morph into being a police state `foxcon model` for most citizens of the developed world. I fear the steady march of the corporate / police state far more than a quick collapse of evaporated financial assets and broken supply chains. Individuals can take responsibility and prepare to come out the other side of a sudden collapse, but remaining `free` from the shackles of what looks more likely is possibly impossible.    

brettd's picture

You'll see demographic shifts:  Out of New England/Ohio and into the south & southwest.

Waterfallsparkles's picture

Although Wall Street always likes Buy Backs and rewards the Stock.  I have always seen the Buy Backs as negative. 

I believe that when a Company reverts to Buy Backs they know they are going to miss earnings revenues and need to reduce the number of shares so that the earnings are based on the lower amount of Shares outstanding.

narnia's picture

what's the alternative, dividend the cash to shareholders & subject it to double taxation?