This page has been archived and commenting is disabled.

Last Time Corporate America Did This, The Stock Market Crashed

testosteronepit's picture




 

Wolf Richter   www.testosteronepit.com   www.amazon.com/author/wolfrichter

The S&P 500 stock index bumbles to new highs no matter what. But it has been a slog: serial GDP downward revisions forward and backward, unceremonious abandonment of “escape velocity” for the fifth year in a row, wars or civil wars in Ukraine and Iraq with consequences for gas supplies to Europe and oil supplies to the world, US inflation heating up. And stocks nevertheless rise because.... The Fed Rules, Metrics and Ratios Are Just for Decoration.

In the Business Roundtable’s second quarter CEO survey, the chiefs of the largest US corporations weren’t exactly in an ecstatic mood either. They lowered their GDP growth forecast for the year to 2.3%; among other tidbits, they also expected to spend less money on capital investments.

Capital investments are crucial to the economy. One, they crank up GDP when the money is spent. And two, investing in productive assets creates future growth. But only 44% of these CEOs are planning to increase capital investment, down from 48% last quarter.

Companies axe capital investments brutally when dark clouds appear at the horizon. It started in early 2000 as the stock market was blowing up and lasted through the recession that followed. Then capex recovered and peaked in the summer of 2008, even as the financial crisis was spreading. In either case, that sudden cut in corporate investment deepened the recessions. This chart of new orders of non-defense capital goods (St. Louis Fed) shows the brutality of the cuts – for example, slashing them by a third from $69 billion in August 2008 to $46 billion in April 2009:

But note how the chart has stayed within its range over the last two decades – a time when the US population has soared 19% and GDP, adjusted for inflation, 51%. Turns out, corporations had found other things to do with their money: stock buybacks.

Which have been skyrocketing. In the first quarter, buybacks jumped 50% from a year ago to $154.5 billion, according to FactSet‘s report released yesterday. It was the third-largest in the data series, behind only 2007 when in Q2 and Q3 $161.8 billion and $177.9 billion were spent on buybacks, while the financial crisis was already fermenting underneath.

Tech blew $47.4 billion on buybacks, a record in the data series, up 175% from a year ago. A cool $18.6 billion of that came from Apple. IBM was in second place with $8.3 billion. Industrials, up 119% from a year ago, also set an all-time high. Overall, Apple and IBM led the pack, followed by FedEx, Boeing, Abbott Laboratories, Corning, and eBay.

For the trailing 12 months, our corporate heroes bought back $535 billion – funded largely with borrowed money – a notch below the $603 billion record set during the trailing twelve months ended in Q3 2007, on the eve of the financial crisis (chart by FactSet):

Buybacks peaked precisely at the top of the market in Q3 2007 then plunged over 80%. By Q2 2009, when stocks were cheapest, buybacks had nearly stopped. It seems like a clockwork of bad timing: buybacks soar when stocks go into bubble mode and collapse when stocks get cheap. But the relationship works the other way around.

The purpose of buybacks is to use shareholder equity to manipulate up the stock price. It works in three ways: one, through the sheer buying pressure – especially easy during these times of super-low trading volume; two, through this form of financial engineering that boosts earnings per share by lowering the share count, though it does nothing for actual earnings; and three, through the hype surrounding the buyback announcements and even the whispers of them.

And it works even when, as for example in IBM’s case, revenues and actual earnings are crummy for two years in a row, and when the stock should be roasting in purgatory. At every earnings announcement, the stock plunges, but then over the next three months, mirabile dictu, the share price rises again, fired up by buybacks. The Wall Street hype machine uses them as bait. Investors swallow them hook, line, and sinker. But that’s all buybacks do.

What they don’t do is generate future revenues and earnings, unlike R&D or capex or any of the other productive activities companies undertake. In this way, the moolah blown on buybacks simply disappears as a driving force from the economy – an issue that has been dogging the US for two decades, as the range-bound chart above shows.

But the tide seems to be turning, and the money seems to be ebbing. Most of the top buyers have already indicated that they’re cutting back. A couple of days ago, FedEx announced that it whittled down its buybacks from $2.8 billion in Q1 to $1 billion this quarter. When Apple raised its buyback authorization through December 2015, it worked out to be $6.3 billion per quarter – down from $18.6 billion in Q1. IBM slashed its full-year buybacks by about $2 billion per quarter for the remainder of 2014. GE disclosed that it would cut its buybacks. Exxon Mobil, AT&T, Oracle, and Wal-Mart already reduced their buybacks in Q1 from the average quarterly amounts in 2013.

So what happens to the stock market when these huge and reckless buyers with their nearly endless resources and ability to borrow at practically no cost start cutting back after such a phenomenal peak? Well, we know what happened when they did the last time: the stock market crashed.

There comes a time when risk just disappears, when nothing can go wrong, when there are no dark clouds on the horizon. The Fed has a measure for it: the Financial Stress Index. Read.... Last Time this happened, The Financial Crisis Broke Out

 

- advertisements -

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.
Sat, 06/21/2014 - 14:34 | 4880864 U4 eee aaa
U4 eee aaa's picture

Is this correlative or causative. Since they are borrowing money to do these buybacks, I think it is more correlative. What caused them to stop buying back in 2008? Was it possibly Bernanke cranking up interest rates and forcing his pin into the bubble(just like what caused the depression)?

Sat, 06/21/2014 - 03:59 | 4880143 zipit
zipit's picture

RE: "The purpose of buybacks is to use shareholder equity to manipulate up the stock price. It works in three ways":

The real reason they do this is to pump up the share price so they can exercise the options (and immediately sell the stock) they issue themselves at the lows.  

The cycle works like this (1) Issue massive number of options to selves during depths of crisis and stock crash; (2) Stock prices recover, time passes, options vest; (3) Pump stock price to a frenzied crescendo; (3) Exercise options and sell the stock.  Wash, rinse, repeat.

Fri, 06/20/2014 - 18:43 | 4879410 AdvancingTime
AdvancingTime's picture

Companies have borrowed money at super low interest rates and are buying back stock because they can't find any other safe place to invest the money. It is pointless to expand in a no growth economy. The reality is that much of what we see on the economic landscape is a mirage, all of us who own businesses would be adding workers if our phone was ringing off the hook and a demand existed for our products, but that situation simply does not exist.

Like everyone else in my industry I'm sitting on empty office space and buildings, cutting cost, and waiting for demand to increase. Constructing more new buildings while paying taxes, insurance, and maintaining a huge supply of empty space makes no sense except to those in government that are not using their own money. The article below goes into why I see no point in hiring new workers.

http://brucewilds.blogspot.com/2012/11/i-would-be-hiring-if.html

Fri, 06/20/2014 - 23:22 | 4879933 Seer
Seer's picture

Early in the game I wondered whether this wasn't about regaining more control over individual businesses by businesses themselves rather than whipsawed all over the place by various WallStreet players.  Seems that one could make a strong argument for this being the motive: not sure if it's primary or secondary, but I can see value here.

Sat, 06/21/2014 - 05:46 | 4880181 ebear
ebear's picture

If you have 20M shares outstanding and you buy back half of them, does Wall street now have less, or more ability to run your share price?

If you issued stock for $10/share then buy it back for $20/share are you ahead, or did you just waste $10 of shareholder equity?

Buybacks makes sense when stocks trade below the price paid for them plus whatever that equity earned over the period in question.  Otherwise it's a net loss.

http://www.capital-flow-watch.net/stock-buybacks-and-the-sp-500/

 

Sat, 06/21/2014 - 08:15 | 4880258 ejmoosa
ejmoosa's picture

Buybacks make sense when

 

A) You want to drive the earnings per share up faster than you can drive profits up.

B) You have run into a diminishing return on assets if you expand your business. The ROI today is so low today it does not reward you to expand.  See CAPEX for evidence this is going on across the board.

 

We have both of those scenarios today.

Sat, 06/21/2014 - 09:31 | 4880315 RaceToTheBottom
RaceToTheBottom's picture

And of course the real driver of things:

C. Your bonus plan rewards you for it....

Fri, 06/20/2014 - 18:34 | 4879391 AdvancingTime
AdvancingTime's picture

Please note the FRED chart includes a shit load of cars being produced for an artificial super low interest rate market that did not exist in 2006. The economic recovery that the media and talking heads have been bantering around does not exist and is just a myth. A manipulated stock market distorted by recent economic policy hides and mask the real truth, in many ways it is ground zero in the war to convince us all is well.

The American people and Main Street will tell you they are far from convinced that it is smooth sailing ahead. Huge weakness in the economy has been shown by numbers that barely get by even after record amounts of stimulus. Fact is if QE or the massive government deficit spending that props up our economy is removed it will fold like a cheap umbrella.

Recent changes in how the GDP is figured , which boosted growth thus reducing the debt to growth ratio, and attempts to spin poor numbers regarding employment have been met with skepticism. More on this subject in the article below.

http://brucewilds.blogspot.com/2013/10/myth-of-economic-recovery.html

 

 

Fri, 06/20/2014 - 16:02 | 4879094 scraping_by
scraping_by's picture

The purpose of buybacks is to use shareholder equity to manipulate up the stock price.

It's also C level welfare, the ruling class of a corporation using company cash to buy their stock bonuses. Because gifting themselves directly out of the cash account is such bad optics. Better to sanitize it through equities. That's why they always go big at the top of the market.

Sat, 06/21/2014 - 12:05 | 4880556 swmnguy
swmnguy's picture

Also a lot of top C-level execs get compensation tied to EPS (Earnings Per Share).  In a market environment where even the most naked accounting scams provide decreasing earnings profiles, massive share buybacks decrease the denominator.  With fewer shares outstanding, stagnant earning can still make EPS pop.

Ka-Ching!

Fri, 06/20/2014 - 18:32 | 4879388 I Write Code
I Write Code's picture

Excellent point!  Of course it's rather inefficient, but it's not really their money being used so who cares.

Sat, 06/21/2014 - 07:29 | 4880213 andrewp111
andrewp111's picture

But the suits probably got the bulk of their stock options at the bottom of the market. So for them, it is really getting low and selling high.

Fri, 06/20/2014 - 16:32 | 4879176 Panafrican Funk...
Panafrican Funktron Robot's picture

Good sir, are you accusing the C suit group of money laundering?  How dare you!!

Fri, 06/20/2014 - 16:00 | 4879083 world_debt_slave
world_debt_slave's picture

Greed Is Good-Gordon Geckko

Fri, 06/20/2014 - 15:54 | 4879066 yellowsub
yellowsub's picture

Winter isn't over yet!  

Fri, 06/20/2014 - 15:12 | 4878914 I Write Code
I Write Code's picture

It's different this time at least quantitatively, we have to burn off $10,000,000,000,000 in Fed and Deficit since 2008.  And I think you're constantly confusing cause and effect here anyway.

We may repeat the pattern at some point due to cycles or karma or something, but $10t (and counting) buys you some time anyway.

Fri, 06/20/2014 - 15:11 | 4878897 Frilton Miedman
Frilton Miedman's picture

 

 

Great observation.

The one caveat is linking buybacks as being solely causal to the 2008 crash, while it obviously contributed, banks investment fraud was the primary cause.

That said, buyback levels might be a pretty good forward indicator in conjunction with "dumb money", which at this time is also flooding the market.

Arguably, banks themselves are still engaging in fraud, I just think they've smartened up since 2008 and learned to diversify their fraud so it isn't as easy to pinpoint.

Instead of pumping up a single sector, as with CDO's & oil in 2008, they've learned to utilize smaller, more diversified bubbles & crashes.

 

Sat, 06/21/2014 - 07:35 | 4880215 andrewp111
andrewp111's picture

But if we are short of the peak of 2007, then we might have a ways to go before it crashes. This time there is no bursting real estate bubble to take everything down. Corporate debt (and oil prices)  are the only things that could be a primary cause, and corporate debt has a lot of room to get more levered up.  The slowdown in recent purchases could be a temporary pause - just like it was for the Russell 2000.

Fri, 06/20/2014 - 15:01 | 4878774 Jam Akin
Jam Akin's picture

Maybe the party continues regardless of buyback volume and capex levels if central banks and large government-run funds continue buying up the remaining half of all publicly traded equity globally?

Fri, 06/20/2014 - 14:35 | 4878760 Tyler Durden
Tyler Durden's picture

As we reported a month ago, Q1 buybacks as actually reported on the cash flow statement, have vastly surpassed the 2007 peak.

Sat, 06/21/2014 - 07:44 | 4880226 andrewp111
andrewp111's picture

The value for the present is actually the same on both graphs. Q2 and Q3 2007 (which are the peaks in the blue graph) are not indicated in the above graph as it starts in Q4. As far as I can tell, the graphs are about the same, but cover a different range.

Fri, 06/20/2014 - 16:58 | 4879216 TVP
TVP's picture

Is this bad?

 

It looks bad.  

 

I want a talking head to explain why it's a sign of economic growth.

It's pure entertainment at this point.  

Fri, 06/20/2014 - 16:32 | 4879175 Ludwig Von
Ludwig Von's picture

Maybe they just don 't believe in a future for their own companies and are prepping up for the big bang(s). 

Fri, 06/20/2014 - 17:25 | 4879269 mt paul
mt paul's picture

let the market roll over

or cause the market to roll over

 

then get your buy backs

at a much cheaper price 

Fri, 06/20/2014 - 15:34 | 4879000 NotApplicable
NotApplicable's picture

Three CapEx bubbles and counting.

Fri, 06/20/2014 - 20:04 | 4879498 RevRex
RevRex's picture

Obama said this proves we need amnesty for illegal alien criminals....

 

 

Anyone remember how the Socialist Semite Democrat media howled when Bush  proposed a Guest Worker Program, yet they say nothing (except heaping praise on Obama) when the ObowelMovement proposes full amnesty.....

Do NOT follow this link or you will be banned from the site!