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"The Buyback Party Is Over" - Albert Edwards Warns The "Market Is Now Running On Fumes"

Tyler Durden's picture




 

While we have yet to do the actual math on the now-concluded second quarter earnings season, to find out if spending on buybacks surpassed the Q1 record, one thing is still quite clear: with the impact of Fed's QE fading, if only for the time being, buybacks remain the marginal driver, and according to some only driver, of stock market upside in 2014. This was shown explicitly in this chart we posted three months ago:

 

However one person who has decided not to wait in declaring the buyback party over, is SocGen's Albert Edwards, the same person who correctly forecast back in late 2012 the epic scramble by investment grade (and high yield) companies to lever up, incidentally, to record levels crushing all the endless blather that there is some massive corporate deleveraging going on.

This is what Edwards said in his latest note:

Much has happened over the summer, but two landmark firsts have occurred only recently, with the S&P500 breaking above 2,000 and the 10y bund yield breaking below 1%. Our Ice Age thesis has long called for sub-1% bond yields and I see this extending to the US and UK in due course. It is the equity markets where I have been consistently surprised. QE has been an essential driver for the equity market, providing the fuel for the heavy corporate bond issuance being used for share buybacks. Companies themselves have been the only substantive buyers of equity, but the most recent data suggests that this party is over and as profits also stall out, the equity market is now running on fumes

In other words, while QE has been the permissive factor enabling companies to engage in zero cost debt-funded stock repurchases, it was corporate CFOs and Treasurers who, in lieu of traditional retail and institutional buyers, have been the marginal buyers of stocks in the tail end of the most ridiculous, rigged, and as CNBC likes to call it, "unloved" rally of all time.

Here is the bad news:

It is widely accepted the Fed?s QE programme has inflated asset prices way above fundamental values (higher inequality being one unwelcome by-product). Andrew Lapthorne has identified the mechanism whereby QE, by shrinking the available stock of investable government bonds, has encouraged investors to instead gobble up other debt assets all along the risk spectrum. Companies issuing at low yields into this buying frenzy are doing what they always like doing with debt in the final throes of an economic cycle ? they issue cheap debt to buy expensive equity. Decent profit (cashflow growth) may be more than sufficient to cover capital expenditure and dividends, but a gargantuan funding gap emerges as companies also undertake their corporate finance zaitech activities (see chart below, Andrew also calculates that currently almost a third of all buybacks are to cover the expense of maturing management share options ? QE is indeed making the rich richer!).

 

Of course, none of this is new: this particular cycle always mean reverts, as does the business cycle itself: the same business cycle which the Fed, with its infinite manipulation of all asset classes, and in its infinite stupidity, thinks it can control and delay the onset of the recession, when all it is really doing is making the drawdown that much more severe when it ultimately, and inevitably does hit:

... the elephant in the equity buying ring has been the US corporates themselves (see chart below), who have been hoovering up stock at a prolific pace from the household sector (mainly) financed by debt (see chart below). This is a normal cyclical event but made easier this time around by QE.

 

 

In retrospect there can be little doubt that QE has washed through the financial markets and elevated share prices via this route. The problem is that this pro-cyclical event has a habit of stopping suddenly for the usual reasons ? i.e. recession or a closure of the credit markets, etc. Andrew in his 18 Aug note shows that is exactly what seems to have happened in the latest Q2 data where share buybacks have actually declined dramatically on both a QOQ and YOY basis. He believes the end of QE may be directly responsible for this - see Bye-bye buybacks ? the end of QE is already being felt in the equity market.

The good news, if only for those sick of all the endless Fed manipulation of every asset class, something even Steve Liesman finally acknoledges, is that is if finally all ending...

This pro-cyclical process always ends in tears and is regarded in retrospect as typical end-of-cycle madness. For when the funding for corporate bond issuance stops (for whatever reason, i.e. QE ends), share buybacks also stop and one of the biggest drivers for the equity bull market is removed.

 

 

The equity bubble has disguised the mountain of net debt piling up on US corporate balance sheets (see charts below). This is hitting home now QE has ended. The end of the buyback bonanza may well prove to be decisive for this bubble. Indeed - is that a hissing I can hear?

... at which point the Fed will have no choice but to step in again, and the central-planning game can restart again from square 1, until finally the Fed's already tenuous credibility is lost, the abuse of the USD's reserve status will no longer be a possibility, and the final repricing of assets to their true levels can begin.

 

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Thu, 08/28/2014 - 12:56 | 5154425 LawsofPhysics
LawsofPhysics's picture

Please, when you have a printer, the party never ends...

Thu, 08/28/2014 - 13:01 | 5154467 kliguy38
kliguy38's picture

BTFD....BTFD........its all good its all good....................till its not

Thu, 08/28/2014 - 14:43 | 5155051 mtl4
mtl4's picture

Reminds me of the story of a woman who told her doctor every year for 50 years she was sure she had cancer and finally one day her doctor said you're right.

Thu, 08/28/2014 - 13:05 | 5154492 Dr Strangemember
Dr Strangemember's picture

Hmmmmm... but I can still buy the dips, right?

Thu, 08/28/2014 - 13:16 | 5154552 NOTaREALmerican
NOTaREALmerican's picture

And, don't forget, because the pathological pessimists have been "keeping their powder dry on the side-lines" for the last 7 years, we'll be able to buy the 70% dip and then we'll control the world and get all the females with the largest teeth and hair. 

Thu, 08/28/2014 - 13:53 | 5154783 Joe Davola
Joe Davola's picture

Andrew also calculates that currently almost a third of all buybacks are to cover the expense of maturing management share options

Now what is the reason buybacks will stop?

Thu, 08/28/2014 - 13:08 | 5154510 RattNRoll
RattNRoll's picture

A printer and an endless supply of cocaine!

Thu, 08/28/2014 - 13:24 | 5154612 RockRiver
RockRiver's picture
"Market Is Now Running On Fumes"

I hope to keep seeing headlines like this. The more we see them the more the market will rally and up is good if one is long....


Thu, 08/28/2014 - 14:16 | 5154905 Postal
Postal's picture

Says someone who doesn't have to fix the darn things.

http://theoatmeal.com/comics/printers

Thu, 08/28/2014 - 18:04 | 5156048 RiverRoad
RiverRoad's picture

Ah, ah, ah........when the ink runs out hi ho, hi ho, it's off to war you go.

Thu, 08/28/2014 - 13:00 | 5154453 NOTaREALmerican
NOTaREALmerican's picture

Graphs....

Thu, 08/28/2014 - 13:25 | 5154606 Dr Strangemember
Dr Strangemember's picture

Remember the earthquake in N. California the other day?  Yeah, I kinda forgot about that too.  

 

Carry on...

Thu, 08/28/2014 - 13:02 | 5154477 taketheredpill
taketheredpill's picture

 

 

I would feel more comfortable about this being close to over if stratagists like Edwards were being fired.

Thu, 08/28/2014 - 13:03 | 5154483 Syrin
Syrin's picture

Gee, I've never heard this before.   Hasn't the market been running on fumes for the better part of a decade now?

Thu, 08/28/2014 - 13:27 | 5154626 Raoul_Luke
Raoul_Luke's picture

Exactly!  The only one I will listen to for a signal on this is Mr. Market himself.  It is certainly possible I suppose that we could wake up to an open 5000 Dow points lower some day, but I doubt it.  It's quite likely that the market will flash negative technical signals in time to get short ahead of "the big one."  Until then you have to be long this crazy train...

Thu, 08/28/2014 - 13:28 | 5154637 PrecipiceWatching
PrecipiceWatching's picture

What would said "negative technical signals" look like, specifically?

 

Serious question.

Thu, 08/28/2014 - 13:59 | 5154806 Raoul_Luke
Raoul_Luke's picture

An accumulation of days marked by volume selling.  It happens periodically.  I was short market indeces as recently as a few weeks ago - but I still had a few individual longs.  Back to all long for now.  Also following the Dow Theory which looks like it is close to signalling a primary bear sign if we don't see confirmation of the S&P new high soon.

Thu, 08/28/2014 - 15:48 | 5155361 PrecipiceWatching
PrecipiceWatching's picture

Thank you.

Thu, 08/28/2014 - 13:46 | 5154745 taraxias
taraxias's picture

Who is this "Mr Market" you are referring to?

I haven't seen a "Mr Market" around since about March 2009 when Bernanke buried him alive. 

Thu, 08/28/2014 - 14:01 | 5154823 Raoul_Luke
Raoul_Luke's picture

Haha!  Good point - but whatever this thing is it's still sending technical signals!

Thu, 08/28/2014 - 13:29 | 5154636 Bluntly Put
Bluntly Put's picture

The great engine of "growth" i.e. a continually degrading interest rate structure is zero bound. Kinda hard to roll that big ole pile of debt over when you can't make credit cheaper.

Thu, 08/28/2014 - 14:00 | 5154819 explosivo
explosivo's picture

As long as there are shares outstanding, there are shares that can be bought back. This madness doesn't end like this. 

Thu, 08/28/2014 - 13:04 | 5154487 JRobby
JRobby's picture

Borrow MEGA FIATSO $$ from TBTF credit facility - check

Buyback large chunks of company shares and retire them - check

Next?

Thu, 08/28/2014 - 13:44 | 5154730 slyhill
slyhill's picture

Insiders take advantage of recent stock gains to cash out for "tax purposes."

Thu, 08/28/2014 - 13:09 | 5154496 Son of Captain Nemo
Son of Captain Nemo's picture

Best news I've heard in 7 years... Ready for the Martial Law party to commence in full swing!

Congratulations America you've earned it!!!

Thu, 08/28/2014 - 13:13 | 5154527 q99x2
q99x2's picture

FED software doesn't run on fumes.

Thu, 08/28/2014 - 13:15 | 5154545 saveUSsavers
saveUSsavers's picture

The Big Boyz Mafia Underwiriters are PROPPING FOR ALIBABA -I said this months ago and nobody believes it?

Thu, 08/28/2014 - 13:23 | 5154602 Ban KKiller
Ban KKiller's picture

Fumes alright. Gas from a bloated corpse of accounting corruption that is Wall Street today. 

Thu, 08/28/2014 - 13:33 | 5154662 TrumpXVI
TrumpXVI's picture

Nope.

Not buyin' it.

Not until I get confirmation in a Goldman swirlogram.

Thu, 08/28/2014 - 13:34 | 5154674 buzzsaw99
buzzsaw99's picture

until finally the Fed's already tenuous credibility is lost...

that sir, has already happened

Thu, 08/28/2014 - 13:35 | 5154680 youngman
youngman's picture

I dont think the buybacks are over...as long as someone will buy a corporate bond at 1%...they will keep buying back their stock....it makes their stock price go up...eps go up..and their options look better....all good for the CEOs and such...who needs investment in research....that is so old school....we play for the quarterly gains now...

Thu, 08/28/2014 - 13:55 | 5154789 huggy_in_london
huggy_in_london's picture

well... until debt/equity ratios explode.  

Thu, 08/28/2014 - 13:38 | 5154698 lester1
lester1's picture

So will corporations default on their QE debt if the FED raises interest rates ???

Thu, 08/28/2014 - 13:39 | 5154706 Jim Shoesesta
Jim Shoesesta's picture

S&P to hit 450 with U.S. worse than 'lost' Japan !!!!!!

Oh, and this clown was saying this 4 years ago. Hope he enjoyed missing one of the largest bull runs in history.

You people need to take a look at the history of all these Zerohedge quoted gurus. They are all broken clocks.

http://www.marketwatch.com/story/sp-500-to-hit-450-socgen-strategist-war...

Thu, 08/28/2014 - 13:43 | 5154732 gdiamond22
gdiamond22's picture

another analyst, another 'top' call, more charts, more crap.

Thu, 08/28/2014 - 13:48 | 5154754 Atomizer
Atomizer's picture

Next stage, ZIRP moves to NIRP. Then interest rates rise. Wash, rinse, and repeat. 

Thu, 08/28/2014 - 13:50 | 5154764 taraxias
taraxias's picture

The only thing you need to keep in mind is that the day Albert Edwards s finally right, he will be REALLY right.

Damocles' sword may not fall for a long time but the day that thin string finally lets go, it will be death for anyone lying underneath.  

Thu, 08/28/2014 - 13:53 | 5154785 AdvancingTime
AdvancingTime's picture

Much of the economic landscape is beginning to look like something out of  "Alice And The Looking Glass" A bizarre  and unrecognizable land, a land that is distorted and papered over by ream after ream of paper. This paper has been rolling off the printing presses of central banks all across the world in an attempt to mask reality.

Peter Schiff says, printing money is to the economy what taking drugs is to a drug addict. In the short term it makes the economy feel good, but in the long run it is much worse off. What was once the "long run" or "distant future" may be getting much closer. More on what happens when the momentum ends in the article below.

http://brucewilds.blogspot.com/2013/01/what-happens-after-momentum-ends_...

Thu, 08/28/2014 - 16:37 | 5155624 Chuck Knoblauch
Chuck Knoblauch's picture

I was thinking the same thing about Alice's wonderland.

Life inside the mirror where everything is not as it appears to be.

How did she escape?

I think she drown in her own tears.

 

Thu, 08/28/2014 - 14:07 | 5154857 I Write Code
I Write Code's picture

What fumes?  Other thread points out long interest is less than growth rate - of those businesses that are growing.  Sounds to me like they keep on keeping on, at least for a little bit longer, until ZIRP actually ends.  And ZIRP could maybe keep going even without QE due to exogenous factors.  Yeah nobody saw it coming, so what?

Thu, 08/28/2014 - 18:10 | 5156076 scubapro
scubapro's picture

 

watch the yield spreads.   corporate rates can go up if there is a hint of risk/recession or something else perhaps; while TSYs stay low as a flight to safety.   people see the gdp higher than long rates and say 'rates must go up';  but perhaps gdp will catch down esp given the way gdp is calcd with RnD, inventories, import/export etc.   

weve already seen junk start to spread out, just the first hint of it.  once QE ends that 'marginal' cash goes away and stops buying the frindge, junk bonds.  we could see that pull the rest of corporates up with it some.  mix in some auto loan defaults and a wiggle in the SPX and people will only go to cash or TSYs.  

no one can guess at the coincident event(s) that will occur when spreads widen (that will be the 'cause' I am sure)  but it will happen. 

Thu, 08/28/2014 - 14:35 | 5155011 saveUSsavers
saveUSsavers's picture

Da Boyz are propping for Alibaba IPO in Sept, biggest IPO payday in history ! Watch if it's called off !

http://jessescrossroadscafe.blogspot.com/2014/08/sp-500-and-ndx-futures-...

Thu, 08/28/2014 - 15:05 | 5155168 Atticus Finch
Atticus Finch's picture

How does anyone know whether QE has ended, beyond the word of the Fed?

Thu, 08/28/2014 - 15:55 | 5155397 ejmoosa
ejmoosa's picture

QE has not ended.  It's rate of increase has slowed down.

All matured holdings are being rolled back into QE,

Thu, 08/28/2014 - 15:16 | 5155222 SanfordandSon
SanfordandSon's picture

What if the fumes are nitrous oxide???

Thu, 08/28/2014 - 15:53 | 5155389 ejmoosa
ejmoosa's picture

The last time we were at these annual levels of corporate profits, as reported by the BEA, the S&P 500 was at 1320 or so.

It appears we have two economies, and the broadast of those economies is in the toilet.  The other one, the markets, are not as rosy as they appear.  Eliminate all the one time charge offs and buybacks, and they would resemble the rest of the country.

Enjoy it while it lasts.

Thu, 08/28/2014 - 21:11 | 5156657 cart00ner
cart00ner's picture

Everything that has anything to do with money is rigged to keep the rich - rich, sports, casinos, charitys etc...

Why would we be surprised that the markets are any different?

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