• Pivotfarm
    08/01/2014 - 12:04
    As the slide starts and the stock markets open in the red on the 1st August , it’s now time to take into consideration what it is that will save you on the floor from losing the house, the wife and...

Bubble Finance At Work: How Buyback-Mania Is Gutting Growth & Leaving Financial Wrecks In Its Wake

Tyler Durden's picture




 

Submitted by David Stockman of Contra Corner blog,

Janet Yellen is a chatterbox of numbers, but most of them are “noise”.  And that’s her term.

Yet here is a profoundly important set of numbers that you haven’t heard boo about from Yellen and her mad money printers. To wit, during the “difficult” economic times since the financial crisis began gathering force in Q1 2008, the S&P 500 companies have distributed $3.8 trillion in stock buybacks and dividends out of just $4 trillion in cumulative net income. That’s right, 95 cents of every dollar they earned—including the huge gains from restructurings, downsizings and job terminations—was flushed right back into the Wall Street casino.

 

Self-evidently, the corporate form of business organization is designed such that some considerable portion of net earnings should be returned to their owners each year. But a 95% rate of distribution is a giant aberration. Were this outcome to occur on the undisturbed free market, for example, it would signal an economy that is dead in the water and that participating companies face a dearth of opportunities to reinvest profits in future growth.

Needless to say, that is the opposite of the “growth” and “escape velocity” story that currently excites stock market punters, and is wildly inconsistent with present capitalization rates in the stock market. That is, in a world of permanent zero growth and nearly 100% earnings distribution, the S&P 500′s current 19X PE on reported earnings would be wildly too high. The more appropriate PE would be in high single digits.

So the $3.8 trillion of dividends and buybacks since Q1 2008 reflects not the natural economics of the market at work, but the artificial regime of monetary central planning and the tax-advantaged treatment of corporate debt. Corporations are eating their seed corn because boards and CEO’s function in a Fed-created financial casino where they are massively incentivized to feed the fast money beast with ever larger share buyback programs in order to shrink the float and goose per share earnings. Doing so generates plump stock option gains, and failure to do so will bring on the black plague of shareholder “activists” agitating for big stock buybacks with borrowed money, and a new CEO and board, too.

Moreover, this pattern is owing to the fact that the Greenspan/Bernanke/Yellen “put” under the stock indices has destroyed two-way markets and the natural short interest that arises in any honest securities market. Accordingly, “downside insurance” against a decline in the broad market has become dirt cheap—as currently reflected in rock bottom VIX levels—-and has therefore enabled Wall Street gamblers to chase momentum plays at will. Stated differently, the momentum chasing hedge funds which drive the corporate buyback mania would not be nearly as profitable—-or massively sized—- if the Fed were not effectively subsidizing their downside hedges.

By now this syndrome has become so completely entrenched that the big cap corporate universe functions as an integral component of the Fed’s serial bubble finance cycle. As shown below, the pattern is wildly pro-cyclical, meaning that corporate cash increasingly fuels the bubble as stock prices reach their peak. Just prior to the financial crisis in Q1 2008, for example, share buybacks and dividends among the S&P 500 companies amounted to 130% of net income—-a distribution rate which plunged to just 65% during the dark days of Q1 2009.

But now we are off the races once again. The distribution rate reached 88% in CY 2013 and came in at nearly 110% in Q1 2014. In short, as financial markets reach their Fed induced bubble peaks, companies spend all they earn and all they can borrow chasing their stock prices ever higher. Indeed, during the most recent quarters, share repurchase programs have been the marginal bid which has propelled the stock indices to their current nosebleed heights.

Corporate stock buybacks thus function as a bubble cycle accelerator, meaning that they are making each new Fed reflation cycle more extreme and unstable. Prior to Greenspan’s irrational exuberance moment in December 1996 share buybacks amounted to about 1% of the S&P 500′s aggregate market cap. By the 2007 peak, they exceeded 5% and are heading in that direction once again—this time accompanied by a rising rate of regular dividend payouts, as well (not shown).

It does not take much analysis to see that this kind of financial engineering results in the inflation of existing financial assets, not the creation of new productive capacity. The graph below on net investment in fixed business assets is the smoking gun. The annual nominal level of net investment has not increased since 1997, meaning that after about 2% average annual inflation—real investment in new capacity in the US economy has shrunk by nearly 30% in the 16 years since the first Greenspan bubble began its final ascent. Stated differently, as the Fed’s money printing has ballooned and amplified the financial bubble cycles, the trend in real capacity growth has steadily worsened.

Needless to say, no Fed minutes ever even hint at the corporate seed corn that is being consumed or the perverse behavior in the C suites that has been induced by monetary central planning. Instead, its all about the “noise” emanating from the high frequency in-coming data.

Also unremarked is the fact that the share buyback mania leaves competitively challenged businesses in a precarious position and unable to weather downturns in the general business cycle or in their own sector.

Radio Shack is a prime example. It is now tottering on the edge of bankruptcy, and there is no doubt whatsoever that this is owing to a giant strategic error by its management and board. To wit, during the past 13 years it repurchased $3 billion of stock on the back of only $2.1 billion in cumulative net income. Indeed, in seven of those years it flushed back into the market more than 100% of its earnings—including $400 million of buybacks in 2010 on only $200 million of net income.

Today it is in a liquidity crisis, with barely $60 million of available cash. The article here fills in the grisly details about how this case of corporate hara-kiri unfolded. But the essential point is that it is not a unique case—just a leading edge illustration of the manner in which the Fed’s destruction of honest financial markets is impairing and gutting the nation’s business economy.

For followers of Austrian economics, it is understood that stock market bubbles are fueled by the Federal Reserve’s monetary pumping; which goes hand-in-glove with artificially low interest rates engendered by the Federal Reserve. Consequently, misleading interest rate and price signals can cause businessmen to make costly errors in judgment.

 

Since stock buybacks, misguidedly, are considered investments in one’s own business, are we not witnessing a massive clustering of errors with innumerable executive management teams authorizing malinvestment on a grand scale?

 

Instead of businessmen misreading market signals and malinvesting in capital and producers goods, many are malinvesting in shares of their own companies via stock buybacks. Like RadioShack, over time, will other companies strip-mine equity until their balance sheets become depleted? Once the current Federal Reserve induced bubbles implode, I’m confident RadioShack will not stand alone as to having gone bonkers, and broke, with buybacks.

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Wed, 07/02/2014 - 20:08 | 4919712 zorba THE GREEK
zorba THE GREEK's picture

The economy is being gutted by the bankers the way petty thieves strip the copper from an empty house.

Wed, 07/02/2014 - 20:11 | 4919723 knukles
knukles's picture

Did you know that "you can’t dump your dog on the street in most of America. But you can dump 50,000 kids from Central America… I was not comparing the children to dogs. I was talking about the difference in law."
   -Rushbo (I know, I know, but it is a great quote)

Wed, 07/02/2014 - 20:16 | 4919736 zorba THE GREEK
zorba THE GREEK's picture

That's because the dogs won't be able to vote democratic later on.

Wed, 07/02/2014 - 21:01 | 4919837 ZerOhead
ZerOhead's picture

Don't be so sure... but first the Democrats have to transcend the hurdle of legalizing Human to Dog marriages.

Considering that dogs were allowed in the military long before gays I like their chances...

Wed, 07/02/2014 - 21:07 | 4919875 disabledvet
disabledvet's picture

Dortmund!

Wed, 07/02/2014 - 21:42 | 4919977 SafelyGraze
SafelyGraze's picture

"RadioShack will not stand alone as to having gone bonkers, and broke, with buybacks."

au contraire!

radioshack cannot be broke when it owns all those shares of it ever-more-highly-valued stock

and it can use that asset as higher-valued collateral against to borrow gazillions more!

 

Wed, 07/02/2014 - 20:20 | 4919752 Moe Hamhead
Moe Hamhead's picture

come on Knuk, Obummer is rying to solve the unemployment problem..........

in Latin America!!

Wed, 07/02/2014 - 20:38 | 4919800 I Write Code
I Write Code's picture

And can you get your dog a free meal and a free bus ticket to Dubuque?

Wed, 07/02/2014 - 21:46 | 4919994 mygameon
mygameon's picture

More like the wire from the pole to the main box. Sheeple will eventually beg the jack boot thugs to hook them up in return for a pledge of fealty and the serfdom of the next 6 generations.

Know thy neighbor or perish. Peace

Wed, 07/02/2014 - 20:17 | 4919741 moneybots
moneybots's picture

"Needless to say, no Fed minutes ever even hint at the corporate seed corn that is being consumed"

 

The purpose of massive financial fraud is to hide the truth.

Wed, 07/02/2014 - 20:20 | 4919743 Caviar Emptor
Caviar Emptor's picture

Why worry? There's no time for work left in people's lives anyway! We're way too busy to work with the spiraling responsibilities of keeping up with mutilple social media, movies on the go, blogging, made for TV series, photo-posting, sports, food trends, DJ mashups, music videos, guarding against identity theft, and oh yeah the news!

Wed, 07/02/2014 - 21:15 | 4919893 deflator
deflator's picture

yeah, way too busy with shit that the FED hedonically adjusts inflation lower with...

Wed, 07/02/2014 - 20:24 | 4919761 BlissPoint
BlissPoint's picture

No buyback surge leading up to the dot-com collapse in 2000. Fed policies weren't as extreme? What's different?

Wed, 07/02/2014 - 20:36 | 4919796 I Write Code
I Write Code's picture

The Fed was only single batshit back then, after 2008 they went double batshit.

But the collapses were different, too.

And the next one will be even differenter.

Wed, 07/02/2014 - 21:12 | 4919885 duo
duo's picture

The company I worked for could have bought all of their competitors for what they spent on stock buybacks over the last 15 years.  Nuff said.

Wed, 07/02/2014 - 21:21 | 4919910 disabledvet
disabledvet's picture

Great question and great answer too. (See below as well.) what isn't mentioned in this "blatant disregard for even truthiness" is capacity utilization. There is nothing new about "Central Planning" (guns and butter...look it up.). What is "newiness" however is the profound lack of lands and labor being put to productive use. And of course since for a time this was almost never the case the question is "what was different about that since?" (That previous time.). And the answer is that "during that time your paper money was backed by physical gold IN A BANK."

The Stock-man might think he is onto some powerful insight...but in fact he's really onto to something Stupid Too Point O as well. Namely "money backed by Government fiction is still all good."

In other words...while this has some excellent data "where's the Government's cut of the action?" The entire article pre-supposes that the Governmet itself is not a rational actor "looking out for its workers paradise." This clearly is not so.

"The power to print is the power to destroy" folks. Rather than get the popcorn I'd head for the hills and give these two behemoths (Wall Street and Washington) a WIDE berth. This looks like the "mash up from" and I think the best thing to be right now is REALLY small.

Wed, 07/02/2014 - 23:18 | 4920222 slightlyskeptical
slightlyskeptical's picture

Gov printing has replaced full production, of which the guns/butter and supply/demand equations demand. Captalism really only works under times of full production. The probem is that 100% + of the money is still being used to buy this lower number of goods or the same amount of lower quality goods.   

Wed, 07/02/2014 - 20:24 | 4919762 what's that smell
what's that smell's picture

mr. trickle down reborn as an austrian randroid.

Crazy Earl: These are great days we're living, bros. We are jolly green giants, walking the Earth with guns. These people we wasted here today are the finest human beings we will ever know. After we rotate back to the world, we're gonna miss not having anyone around that's worth shooting.

Wed, 07/02/2014 - 20:25 | 4919766 moneybots
moneybots's picture

"Since stock buybacks, misguidedly, are considered investments in one’s own business, are we not witnessing a massive clustering of errors with innumerable executive management teams authorizing malinvestment on a grand scale?"

 

It sounds so 1929.

Wed, 07/02/2014 - 21:23 | 4919915 disabledvet
disabledvet's picture

We had a lot less overhead in 1929. Again...good comment...above and below.

Wed, 07/02/2014 - 20:32 | 4919782 moneybots
moneybots's picture

The FED says "the market is wrong", but it is the FED that is forcing the market to be wrong.

Wed, 07/02/2014 - 20:33 | 4919783 I Write Code
I Write Code's picture

 

during the “difficult” economic times since the financial crisis began gathering force in Q1 2008, the S&P 500 companies have distributed $3.8 trillion in stock buybacks and dividends out of just $4 trillion in cumulative net income.

That is just a remarkable statistic.  The question is *how* they were able to do it.  The answer is ZIRP.  And maybe some sub rosa jawboning, that this is exactly what the Fed *demanded* and that there was even further quid pro quo for going along.

However, it is not necessarily 100% inappropriate.  After the bubble burst, let's say that the average publicly traded company had more capacity than it needed and thus more capitalization.  Not only would it suffer from business being cut permanently by 20% or more, but would be further burdened with excess debt and plant, and share prices would stay at 2008 bottoms - yes, let's say pre-ZIRP the stock market crash of 2008 was MOSTLY ACCURATE! But the Bernanke Theorem that rising stock prices would be good for the average Joe if only by trickle-down would only happen with a multi-year effort to refloat stocks to recent highs - based not on business, because that was not going to come back, ever.

And it looks like that's just what we got.

Wed, 07/02/2014 - 23:06 | 4920184 GooseShtepping Moron
GooseShtepping Moron's picture

Code,

Your comments are always worthwhile to read and this one is particularly astute. It is indeed a remarkable statistic and just a remarkable article. The original article at Lew Rockwell's place was very good, too. The opportunity to read analyses like that are the only reason I still bother to pay for an interent connection, but sadly they are few and far between.

Allow me to add one thing to your summation: the huge amount of shares that have been dispensed in pensions and 401(k)s, or have been privately purchased through ETFs. With the Baby Boomers set to retire, the the chance to sell their accumulated assets at the all time highs must be looking pretty attractive right now; but of course, once that process starts to snowball, it's going to knock down equity values pretty hard. All those those extra shares are being slurped up ahead of time by companies positioning themselves for the pension crush in the future.

Now perhaps we have an answer to the question, "Who will the Boomers sell their shares to?" They'll sell them back to the issuing corporation in exchange for ZIRP money, and the companies will simply cancel them because the shares have no reason to exist anymore. Then the prices of consumer goods and especially health care will rise as the old folks chase the few remaining goods there are to be had in a country that has had no capex for 20 years. There will be nothing left to invest and nothing worth investing it in.

When you add to this the problem of crumbling infrastructure, the collapse of the petro-dollar, and any number of other things on the horizon, it's pretty hard to see a happy ending.

Wed, 07/02/2014 - 20:35 | 4919792 Caviar Emptor
Caviar Emptor's picture

Why worry? There's nothing productive left to invest in anyway! Crony capitalists hoarding ill-begotten money is nothing new at all. In the corruption department, We still haven't topped the Grant Administration! Buy an ugly artwork at record price! Buy three!! Make sure your yacht has the most expensive shower curtain on the planet! Mix drinks with only Antarctic ice!
Ah that's my free enterprise! Breathe the air of freedom!

Wed, 07/02/2014 - 21:24 | 4919894 buzzsaw99
buzzsaw99's picture

oooh! a quality scotch poured over blue antarctic ice. has me pining for the fjords.

Wed, 07/02/2014 - 21:13 | 4919883 buzzsaw99
buzzsaw99's picture

the criminal genius of paying out such a large chunk in dividends is that "they" know a good percentage of that money will end up being reinvested in moar shares, driving prices ever higher. i love a good train wreck i just hate having to pay for it.

Wed, 07/02/2014 - 21:20 | 4919907 joego1
joego1's picture

ummmm..... Seed Corn! That was good.... Zirrrrrp!

Wed, 07/02/2014 - 21:26 | 4919925 Shizzmoney
Shizzmoney's picture

The problem with cannibalism is that, eventually, you run out of people to eat

Wed, 07/02/2014 - 21:29 | 4919931 Jerk_Store
Jerk_Store's picture

I thought Radio Shack stock was in the toilet because the algos didn't say BUY BUY BUY

Wed, 07/02/2014 - 21:38 | 4919955 mygameon
mygameon's picture

This is simply MBS Toxic Assets bullshit redo.

Corporations buy back shares with ZIRP fiat. Raise dividends and distribute to the hedgies and banksters. Blow the asset bubble bigger with the sewer mouth ass jack Yellen's help and lever more with more ZIRP fiat then distribute until corporations have a cash crunch and fail by the hundreds. The pension funds, 401ks, and so on go to zero. sHTF and all hell breaks lose because it is then too big to bail.

Stacking, and building hugelkultur's as fast as possible.

Know thy neighbor or perish. Peace

Wed, 07/02/2014 - 21:54 | 4920014 orangegeek
orangegeek's picture

tick tock Janet

 

no amount of bullshit speeches will save your fat ass yellen

Wed, 07/02/2014 - 23:54 | 4920325 IANAE
IANAE's picture

Any idea what amount is TARP (yes, TARP...) funded?

More generally, how many bailout $$ were converted into buyback $$?

 

Thu, 07/03/2014 - 01:05 | 4920437 Lynchie
Lynchie's picture

I love capitalism! Return of excess capital to stakeholders. Lovely.

Thu, 07/03/2014 - 07:12 | 4920808 unitwar
unitwar's picture

What I find interesting is that the 4 trillion in corporate profits roughly equals the amount the fed printed.  I don't really know what conclusion to draw from this?  Just an observation. 

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