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The US Equity Bubble Depends On Corporate Buybacks; Here's The Proof

Tyler Durden's picture




 

Last month in “Who Is Buying?”, we pointed out the glaring disconnect between aggressively negative equity flows and record highs on the S&P and Nasdaq. With some corporate management teams still stuck in buyback blackout limbo, it seemed strange that equities were still being bid given that share repurchases are set to be the biggest catalyst for US stocks in 2015 (as a reminder, Goldman sees pension funds and households combining for outflows in excess of $400 billion). 

As a reminder, is a look at projected net equity flows

... and here’s the peculiar chart...

Whatever the reason(s) for the disconnect (and we suggested a few interesting possibilities), investors needn’t concern themselves too much going forward because starting next week, the debt-fueled buyback bonanza can begin anew, meaning that once again, stocks will benefit from the price insensitive, corporate management bid, all brought to you by yield-starved credit investors who have been perfectly willing to snap up new issuance (which for IG hit a Q1 record this year) and look the other way as companies plow the cash back into their own shares at the expense of future productivity. Here’s Goldman:

Of the 362 companies that have now reported 1Q results, 45% of companies have beaten earnings estimates (below the historical average of 46%) and 11% have missed estimates (vs. average of 15%). Next week, these companies, which represent more than 80% of the S&P 500 market cap, will have exited their repurchase blackout period and may resume buybacks, which should provide renewed support for the market. 

For those who require still more proof that the rally in US equities has become inextricably linked with corporations leveraging their balance sheets to repurchase their own shares, JPM is out with an in-depth look at buyback trends which strongly suggests — unsurprisingly —that buyback activity has indeed been very supportive of US shares over the last several years.

Via JPM:

Apple announced an expansion of its dividend and buyback scheme to return $200bn to shareholders by the end of March 2017, up from $130bn previously. This adds to the flurry of share buyback announcements this year bringing the YTD total of $315bn which in annualized terms ($945bn) is more than double last year’s $450bn (Figure 1). The doubling in announced share buybacks globally appears to be driven by US companies which are tracking a YTD pace that is 2.2 times last year’s pace. Non-US share are 1.4 times last year’s pace…

 

It’s not quite that simple though, because the net amount of shares drained from the market must also take into account LBOs and, on the other side of the equation, IPOs and secondaries… 

First, equity withdrawal is also a function of M&A/LBO activity which adds to the equity withdrawal impact of share buybacks. It is also a function of IPO/secondary equity offering activity which instead reduces the equity withdrawal impact of share buybacks.

When looked at from the perspective of IPOs and secondaries minus buybacks and LBOs what we actually find is that net equity issuance (i.e. more shares in the market, not less) came in at around $136 billion in Q1. 

 


However, calculating equity withdrawal/issuance in this way is problematic…

One drawback is that share buybacks are announced rather than actual. Another drawback is that share buybacks are gross rather than net, i.e. they omit the exercise of stock options and employee stock programs as well as the exchange of common stock for debentures and conversion of preferred stock or convertible securities. One way of adjusting for this to look at quarterly cash flow statements of companies which report actual (rather than announced) buybacks on both gross and net basis. These actual net share buybacks are shown in Figure 3.

 


JPM then strips out the European component and nets IPOs against actual net share buybacks in the US and sure enough, a familiar picture emerges.

How does the picture of net equity issuance of Figure 2 change if one uses actual net buybacks instead of announced gross share buybacks? To answer this question we use a slightly modified formula which looks at the difference between IPOs minus net actual share buybacks and LBOs. Secondary offerings are omitted from this formula because they are already incorporated in net buybacks contained in companies’ cash flow statements…

 

A positive share issuance outside the US has been a persistent phenomenon since the Lehman crisis. While before the Lehman crisis US and non-US companies have been both buying back their own shares, since the Lehman crisis there has been a large divergence with US companies continuing to buying back their shares and non-US companies issuing shares instead…

 

This is also shown in Figure 5. It depicts the net equity issuance of US companies proxied by the difference between US IPOs and actual net US buybacks and US LBOs. It confirms that net equity withdrawal has been rather healthy and steady in the US, rising roughly in line with equity prices over the past four years. 

 

Looking at the chart above it would appear that JPM may be understating the case. Net equity issuance is the most negative (i.e. aggressive equity withdrawals) it’s been since early 2008, and it’s been trending steadily lower for the better part of six years, which of course coincides perfectly with the inexorable rally in US stocks. 

As a reminder, the buyback-fueled rally comes at a cost. When corporations issue debt to repurchase shares, they're taking on interest expense (even if, thanks to the Fed, borrowing costs are low) but are not investing in the future growth they'll need to service the growing debt pile. So while record buybacks can support the rally, artificially inflate EPS, and enrich management teams in the short-run, over the long-haul, financial engineering is not a viable strategy for producing sustainable corporate growth and profitability.

 

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Sat, 05/02/2015 - 10:03 | 6053392 q99x2
q99x2's picture

Does this mean Greece is going to default. BTFD.

Sat, 05/02/2015 - 10:17 | 6053418 Edward Morbius
Edward Morbius's picture

All enabled by the FED and ZIRP.

 

The top management make a fortune in stock options and leave the inevitable blow up to be handled by someone else.

Sat, 05/02/2015 - 10:30 | 6053445 Kirk2NCC1701
Kirk2NCC1701's picture

The financial Reacharound, courtesy of the Fed.

WIG4U*, Lord Bankfine?

* Was It Good...

Sat, 05/02/2015 - 10:53 | 6053495 kliguy38
kliguy38's picture

not even an ear nibble

Sat, 05/02/2015 - 11:07 | 6053528 Colonel Klink
Colonel Klink's picture

Or Bankfiend, AKA moneychanger.

Sat, 05/02/2015 - 10:30 | 6053446 cocoablini
cocoablini's picture

They make a fortune because they also frontrunner their own buying. The SEC can't do shit or else the entire stock market crashes due to low volume. Insider trading rules have all been tossed. Best thing to do is make friends inside the company. Then they also let Congress in on the insider trading.

Sat, 05/02/2015 - 17:53 | 6054419 j reuter
j reuter's picture

I'm making over $7k a month working part time. I kept hearing other people tell me how much money they can make online so I decided to look into it. Well, it was all true and has totally changed my life. This is what I do... www.jobs-review.com

Sun, 05/03/2015 - 07:39 | 6055836 Eugend66
Eugend66's picture

Go away, bot.

Sat, 05/02/2015 - 10:06 | 6053398 worbsid
worbsid's picture

This is great: When they get all their stock bought back, the price will go down, then BTFD.

Sat, 05/02/2015 - 10:09 | 6053403 This is it
This is it's picture

Hey, it works. So who cares.

Let's go fishing.

Sat, 05/02/2015 - 10:31 | 6053447 GMadScientist
GMadScientist's picture

"Hey, isn't this where we left the motor home, Ma?"

Sat, 05/02/2015 - 10:14 | 6053410 Monetas
Monetas's picture

Using cheap money .... to allow your stockholders .... to get out "whole" .... and reward those who stay .... sounds like a no brainer ?

Sat, 05/02/2015 - 10:27 | 6053422 GMadScientist
GMadScientist's picture

Then book it as dividends and let the chips fall where they may.

This isn't about "the stockholders" as much as "the senior stock holders" getting "out from under" (what you call 'whole') before 'le deluge'. It's difficult to unload major blocks of shitheap stocks with LSD-inspired EPS when you have to dance around SEC reg rules etc (as execs do, if they wanna not play tennis in kiddy-jail for a few years anyway), but if you've got a guaranteed buyer of last resort with nothing to lose but Yellen's money, then you too can unload and sail to the Bahamas with civilization burning in your rear-view.

Monetas, I thought you knew better. :p

Call it "Barbarians at the Exits", if that helps it "resonate".

Sat, 05/02/2015 - 10:33 | 6053450 Buckaroo Banzai
Buckaroo Banzai's picture

"Senior stock holders"?? Huh?? Who the fuck are they?

No, this is all about stock options. The number one goal of stock buybacks is to transfer wealth from shareholders to corporate executives and employees.

Sat, 05/02/2015 - 10:56 | 6053501 GMadScientist
GMadScientist's picture

"as execs do"

Don't be a fucking dunce.

Sat, 05/02/2015 - 13:28 | 6053874 cheech_wizard
cheech_wizard's picture

half right...

The number one goal of stock buybacks is to transfer wealth from shareholders to corporate executives...

 

Sat, 05/02/2015 - 10:19 | 6053421 GMadScientist
GMadScientist's picture

Hmmm...leverage...seems like a dubious choice if the future includes that equity vaporizing along with any remaining demand in the economy. Ah, who am I kiddin', Yellen's good for it.

Sat, 05/02/2015 - 10:20 | 6053423 rsnoble
rsnoble's picture

So why didn't it work in '08?  Oh yeah........trillions in free money?

Sat, 05/02/2015 - 10:21 | 6053424 Midnight Rider
Midnight Rider's picture

I would imagine at best this will hold prices where they are for a big longer while the smart money sells their overpriced shares back to these companies. Not sure I'd look for a lot more upside. Churn at the top while these companies eat themselves alive cashing out just as the vapors burn out. Remember there has been some massive insider selling going on. Stay tethered to your chair before it disappears through the rabbit hole of vanishing liquidity.

Sat, 05/02/2015 - 10:25 | 6053432 Monetas
Monetas's picture

Corporate Prepping !

Sat, 05/02/2015 - 10:28 | 6053436 GMadScientist
GMadScientist's picture

Corporate propping!

Sat, 05/02/2015 - 10:29 | 6053433 BlowsAgainstthe...
BlowsAgainsttheEmpire's picture

q

Sat, 05/02/2015 - 10:30 | 6053444 GMadScientist
GMadScientist's picture

It puts the link back or it gets the basket again.

Sat, 05/02/2015 - 10:32 | 6053449 BlowsAgainstthe...
BlowsAgainsttheEmpire's picture

Another way of looking at it . . .

 

http://tinyurl.com/k74klt9

Sat, 05/02/2015 - 10:28 | 6053434 AIIB
AIIB's picture

So, which semester at Harvard does one usually take PYRAMID SCHEME 101 for CEO's? Is it a pass/fail course? Is golden parachute skydiving an intramural activity for those who suck at crew?

Sat, 05/02/2015 - 10:30 | 6053441 GMadScientist
GMadScientist's picture

You mean for the students or Jabba the Economic adviser himself (Summers)?

Sat, 05/02/2015 - 11:44 | 6053630 AIIB
AIIB's picture

Ha! Good catch! I was trying to figure out a way to weave that Bob Rubin sychophant into the equation but couldn't condense it into one single line.

Sat, 05/02/2015 - 10:55 | 6053499 northern vigor
northern vigor's picture

I think it was the course with a take home exam...the one where everybody copied each other, got caught, and passed with flying colors.

Sat, 05/02/2015 - 10:30 | 6053443 Monetas
Monetas's picture

Hoard, tuck and roll .... in case there's a hard landing !

Sat, 05/02/2015 - 11:03 | 6053516 GMadScientist
GMadScientist's picture

Ah, the low-riders make so much sense now.

Orale pues!

Sat, 05/02/2015 - 10:32 | 6053448 cjt
cjt's picture

IBM has been doing this for the last 6 years on declining revenue--they are the PRO's! But Cramer says BUY BUY BUY! But it's bye bye bye...

Sat, 05/02/2015 - 10:37 | 6053461 Monetas
Monetas's picture

Maybe, Ocramer .... got it right .... for once ?

Sat, 05/02/2015 - 10:39 | 6053466 Monetas
Monetas's picture

A lot of people got rich .... in real estate, stawks and hula hoops .... while we were waiting for gold to catch fire !

Sat, 05/02/2015 - 10:44 | 6053467 Monetas
Monetas's picture

MSM Russian hacker/troll double click .... OK, I go off topic, then .... San Carlos Chronicles .... I traded a pack of duty free Skydancer smokes .... to Flaco .... for three rattle snake skins .... the last time I killed a rattlesnake .... I painted the skin with anti-freeze .... before tacking it on the wall .... trouble is, it has a slight neon green glow .... how can I preserve the natural color .... is there a colorless anti-freeze ?

Sat, 05/02/2015 - 11:22 | 6053562 GMadScientist
GMadScientist's picture

Shellac or painters fixatif, if you really want to hick it up. ;)

Sat, 05/02/2015 - 10:46 | 6053482 CHC
CHC's picture

Corporate buybacks?  Seriously?  We don't need JPM to tell us something everyone already knows.

Sat, 05/02/2015 - 10:55 | 6053500 Ward cleaver
Ward cleaver's picture

Wow, you mean corporations aren't growing the revenue line and instead are cutting costs and using ZIRP to repurchase their stock? OMG, and Kennedy has been shot.

Sat, 05/02/2015 - 10:57 | 6053506 CarpetShag
CarpetShag's picture

And in other news, the British Monarchy diverts the brainless masses by reproducing itself one more time:
http://www.dailymail.co.uk/news/article-3044227/Kate-Middleton-Prince-Wi...

Sat, 05/02/2015 - 11:05 | 6053519 Colonel Klink
Colonel Klink's picture

Boy there's going to be a lot of destruction of value when this thing lets go!  Corporations and many monied families are going to turn large fortunes into small fortunes.

Bring on the shit show!

BONUS ROUND, bankers flying out windows.

Sat, 05/02/2015 - 11:23 | 6053565 GMadScientist
GMadScientist's picture

Guess again...who do you think the sellers of size for buybacks have been?

Bankers will land on piles of handouts.

Sat, 05/02/2015 - 13:34 | 6053880 cheech_wizard
cheech_wizard's picture

>BONUS ROUND, bankers flying out windows.

Standard Disclaimer: And we would like to thank those disgruntled shareholders, who, without their helpful hands, these bankers would not have been able to achieve such a graceful arc while travelling on their way to an asphalt face-plant.

 

Sat, 05/02/2015 - 15:51 | 6054098 pgroup
pgroup's picture

An asphalt face-plant followed by a long dirt nap.

Sat, 05/02/2015 - 11:09 | 6053532 SillySalesmanQu...
SillySalesmanQuestion's picture

We have Michael Milliken, Henry Kravis and Ivan Boesky to thank for this constant circle jerk of corporate profiteering and plundering banking interests...they were way ahead of their time before the algos and HFT.

Sat, 05/02/2015 - 11:28 | 6053578 GMadScientist
GMadScientist's picture

Before there were dark pools for all, there was share parking in Milken's asshole, but their theft and the theft of HFTs (and lies about making liquidity) are completely different sins. The former screwed a few rich stupid people out of their profits (and that's why those guys went down), but the latter screws the market itself.

 

Sat, 05/02/2015 - 12:31 | 6053759 SillySalesmanQu...
SillySalesmanQuestion's picture

I don't disagree GMad, they were just the first to creatively saddle companies with cheap debt to inflate the stock price and enrich the insiders in the company. They just used different tactics in the day :)

Sat, 05/02/2015 - 15:56 | 6054110 pgroup
pgroup's picture

What's really fascinating is that the feds allowed Millkin to secretly unwind his holdings before arresting him (and keep his stolen profits) so as to avoid spooking the markets into a crash.

My, how times have changed.

Sat, 05/02/2015 - 11:46 | 6053629 BGO
BGO's picture

The article mentions corporations are using their own money to buyback their own stock. I thought one of the things that makes the (current) buyback schemes unsavory is that they are being financed with bank loans. Maybe I'm wrong. It's confusing.

Sat, 05/02/2015 - 12:18 | 6053734 Max Cynical
Max Cynical's picture

Other than boosting EPS, what other reason is there for companies to buy back its shares...especially at such high valuations?

Is EPS the end all in stock price valuation?

Sat, 05/02/2015 - 16:24 | 6054108 bid the soldier...
bid the soldiers shoot's picture

 

Once upon a time it was all about individual companies boosting their EPS.  But all that changed in the first half of 2009.  Then it was essential that the DJIA jump over the moon, so that upper middle class Americans, most of whose savings were in 401(k)s, be made to feel that they were growing richer during the worst, most fraudulent recovery in the history of American Capitalism.  So in spite of everything that's obvious to the rest of us, these middle class Americans did not lower their consumption, rather they consumed even more.

When companies buy back their shares, they reduce the supply of their shares in the market for both the short term and the long term.  And they increase the demand for their shares which raises the offering price of those shares.

And when that stock is a member of the Dow 30 or the S&P 500, when it goes up, it has magical consequences on all the 15,000 publically held companies.

The Dow goes up, the market goes up, the 401(k)s go up, cconsumer confidence goes up.  

A new kind of recovery. 

Sat, 05/02/2015 - 16:31 | 6054198 bid the soldier...
bid the soldiers shoot's picture

down arrow

I'm glad to see you're not too retarded to use the down arrows.

Alas, I don't think you'll ever be able to write a reply.

Such is the life of the mentally challenged.

.

 

Sat, 05/02/2015 - 23:03 | 6055270 not a yahoo
not a yahoo's picture

Lower taxes than dividends. As far as the market goes, apparently EPS is all there is.

Sat, 05/02/2015 - 16:08 | 6054145 g3h
g3h's picture

If it is buyback, it can't be a bubble.  Since price/value is compensated.

Sat, 05/02/2015 - 17:52 | 6054415 scrappy
scrappy's picture

Pardon my ignorance, what happens if they sell those bought back shares, or are they extinguished?

Sat, 05/02/2015 - 22:59 | 6055265 not a yahoo
not a yahoo's picture

they are extinguished

Sat, 05/02/2015 - 23:07 | 6055264 not a yahoo
not a yahoo's picture

ZH, is there data available to post a long-term-debt/bonds - to - capitalization chart?

Or even better, a debt + capitalization chart, which sort of reflects what all the stake holders think the companies are worth.

Basically, the debt financed buybacks are just a trick to keep PE artificially low.

Sat, 05/02/2015 - 23:19 | 6055297 not a yahoo
not a yahoo's picture

Even if the buybacks were not helping to keep PE artificially low (say high interest expense), and even if they were not responsible for lifting shareprices with artificial demand, they really add hugely to the 'capitalization' of the company. So a true PE would include debt stakeholders, which might look very much worse.

 

One thing I don't get though, can you even finance share buybacks, I thought those have to come out of profits?? I doubt companies are buying shares while reporting losses?

Sat, 05/02/2015 - 23:31 | 6055327 not a yahoo
not a yahoo's picture

OMFG, this is the next accounting scandal! So the only way this can work is if the shares are held on the books as 'treasury stocks'. So basically you have e HUGE hole in your balance sheet, because when the stocks tanks that position is worthless.

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