Buyback Bonanza, Margin Madness Behind US Equity Rally

Tyler Durden's picture

One of the themes we’ve been keen to advance this year is the idea that the rally in US equities is in large part attributable to corporate buybacks. In essence, companies tap yield-starved investors in the debt market and use the proceeds to repurchase shares, thus ensuring a constant bid for their stock while artificially inflating earnings and propping up the value of equity-linked compensation at the same time. All of this comes at the expense of capex (i.e. investing in future productivity and growth) and as we’ve noted on several occasions, is easy to spot if one looks at the divergence in the percentage of companies beating earnings estimates versus the percentage of companies beating revenue estimates.

Over the weekend, we pointed to data from JPM which shows that equity withdrawal in the US (IPOs minus buybacks/LBOs) is the most negative it’s been since early 2008 and has trended lower in lockstep with the long-running rally in US stocks, suggesting yet again that in this case, correlation may indeed imply causation. 

Here’s more from Morgan Stanley on the buyback binge, its relationship to the equity rally, and what it all means for corporate health:

Why Are Companies Buying Back Shares? Lack of confidence in organic growth alternatives, very low cost of debt relative to equity, a struggle to improve ROEs, and relatively flat WACC curves have driven the pace of share buybacks. While buybacks are more conservative than capex or LBOs (both of which are well below last cycle’s peaks), they erode credit quality by draining cash and/or increasing debt, and we expect them to continue. 


The Credit Lens: Buybacks improve “per share” metrics the most, while levering the capital structure. At 2.2x, gross leverage for IG companies is now higher than at the peak of the last cycle. As such, it is important for credit investors to focus on broader fundamental metrics while taking stock rallies with a grain of salt. Indeed, we find that CDS begins to widen 30 days post buybacks, even as the stock price continues to rally. Overall stocks with high buyback ratios have outperformed by 10% since 2013.


As we penned our outlook for US investment grade credit in 2015, one of our top “worries” heading into the year was the rising trend in shareholder friendly activity and more specifically the surge in stock buybacks. In 2014, the constituents of the S&P 500 on a net basis bought back ~$430Bn worth of common stock and spent a further ~$375Bn on dividend payouts. The total capital returned to shareholders was only slightly less than the annual earnings reported. On the fixed income front, the investment grade corporate bond market saw a record $577Bn of net issuance in 2014. While the equity and bond universes don’t overlap 100%, we think these numbers convey a simple yet important story. US corporations have essentially been issuing record levels of debt and using a significant chunk of their earnings and cash reserves to buy back record levels of common stock…



As we noted in a recent report, corporate balance sheets are no longer as pristine as they were in the immediate aftermath of the financial crisis (see Exhibit 2). Gross leverage for the median US IG company (~2.2x) is higher than it was in the 2006-2008 period and is now approaching the highs seen in 2001



Corporations have limited avenues to grow earnings in the long run, given a tepid and long recovery. Since 2012, more than 50% of EPS growth in the S&P 500 has been driven by buybacks and growth ex-buybacks has been a mere 3.3% annualized. Unlike previous cycles, share repurchases could be the primary avenue of re-leveraging in the current cycle in the absence of high growth and financial leverage. In a low-growth, low-return world, the strong trend in buybacks could continue as companies lack alternatives to reward shareholders. Further, as history shows us, companies tend to buy back more stock as the price increases and in a downturn, a sharp sell-off in stock prices will effectively lead to an erosion of the equity cushion.

And in case the above isn’t clear enough, here’s a graphic showing the relationship between equity performance and buybacks…

...and here’s a bit more color…

Looking back at the equity performance of companies that had the highest buyback ratios, we find that this basket has outperformed the broader market by ~73% since the beginning of 2004 (5% annualized). In the current cycle, share buybacks have been on an upswing; since 2013 the outperformance of buyback-heavy stocks has been even starker, at 10% on an annualized basis.



...and as we've pointed out on dozens of occasions, all of this all comes at the expense of capex…

Apart from buybacks, other measures of corporate spending/leverage portray a more benign picture. For example, capital expenditure levels in the 1990s were materially higher over a sustained period of time. Average YoY growth from during this period was roughly 15%. Similarly, after the recession of 2002, CAPEX rebounded strongly and was in double-digit territory over the next 5 years. In the current cycle, CAPEX growth has been tepid at best and with the exception of 2011, has struggled to match the last 2 cycles.


Meanwhile, as WSJ reports, investors are chasing the buyback-fueled rally by doing exactly what corporate America is doing: employing leverage.

Via WSJ:

Borrowing is rising in the stock market as well. In March, stock-market margin debt hit $476.4 billion, the highest level in records going back more than 50 years, according to the New York Stock Exchange.


Rising margin debt “suggests people expect the rally to continue,” said Ana Avramovic, trading strategist at Credit Suisse.


She said margin debt outstanding tends over time to track stock-market index levels. The Nasdaq Composite Index last month hit its first record close since March 2000. The S&P 500 has hit six all-time closing highs this year and the Dow Jones Industrial Average four, and the two U.S. stock gauges have together hit 198 record closes since 2013.

Summing up: record corporate issuance, record buybacks, record stocks, and record margin debt. So when the cycle finally turns and everyone who gorged themselves on corporate debt in a desperate attempt to find yield suddenly discovers just how illiquid the secondary market has become (prompting fire sales) and when the margin calls start for everyone who has borrowed in a frantic attempt to serve as the greater fool for the last guy who bought on margin, don't say we didn't warn you. 

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yogibear's picture

Make each bubble larger than the last.

- A Federal Reserve production.

Headbanger's picture

It's got to make us wonder what its going to look like in real life when it all unravels?

Will all factories, shipping facilities, banks, stores just close all their doors at once?

Then what?

Nobody is thinking about it cause they  still believe all the bullshit.

eclectic syncretist's picture

I see the Golden Boyz are back in town again at 8:30 ahead of the market opening this morning, fleecing the sheep and giving whiplash to all the suckers who sold out to them last thursday and friday, probably singing...

NoDebt's picture

"All of this comes at the expense of capex (i.e. investing in future productivity and growth)"

Nobody gives a shit about that because nobody is expecting future growth.  OK?

Balance sheet pollution is the only downside anyone is even halfway paying attention to in this popular little accounting gimmick.

NotApplicable's picture

Worse than no growth, I'd say there's no way they can even find demand for current production levels.

There's simply no environment left where capex can provide a positive return, so what do they do, but to leverage their credit rating in order to shiny up the facade.

As for the consequences, Janet will either buy the paper outright, or have Wall St. package it up in something 'attractive' first.

Gent's picture

A 'legitimate' Ponzi scheme is still a Ponzi scheme.

spastic_colon's picture

.....and be sure to crush every "old saying".....every time i hear "sell in may and go away" or "rising tide" or "dont fight the trend" etc etc I wanna puke.....its the same as all the dancing idiots on commercials while they're buying furniture, or a car....lowest comon denominator no longer pays to be intelligent.

BullyBearish's picture

But, but, but...nobody saw it coming, we had no warning...

Sir SpeaksALot's picture

both stock marktet and bond market is like a game of lottery today,
everybody wants to play more and more, to win more and more
but the only way to win is to quit playing before everybody else does.

SheepDog-One's picture

I heard my sister talking about seeing a house for sale last nite, way above her and her husbands means, but it's a no brainier she said because it's nothing down and money is free.

Mike Honcho's picture

Different degrees of intellect I get, but some people are in another reality.

spastic_colon's picture

yep sheep, i'm hearing people say how they could have invested in a 50/50 cash/equity index fund and out performed most every diversified portfolio the last 7 years, investing is so easy!

TheFourthStoog-ing's picture
TheFourthStoog-ing (not verified) May 4, 2015 8:04 AM

Eventually equities are going to crash like everything else, but in the meantime count me in. There's nothing else out there to invest in, except maybe high yield.

spastic_colon's picture

golly even uncle warren says he is fooled by the fed, gosh, even as he prob sells into strength, gee i'm sure he gets to be out first.

appocean's picture

At some point Goldman and Co. will have to underwrite the public offerings to exchange these shares back to the public for needed cash... no doubt for expansion and capex spending.

What a vicious crony cycle.  If there is a correction before the companies redivest themselves then some ceos and boards are going to be on the outside looking in... no doubt from their own private islands.

Maybe the trigger for the top will once again be the inside selling of the ceo's selling their options back to their own companies... get ready sec... lol.

Ajax_USB_Port_Repair_Service_'s picture

So, the company execs pump the stock price via buybacks, while selling THEIR PERSONAL STOCK HOLDINGS at the levitated stock prices. Seems to be working quite well.

Just wish my retirement fund wasn’t one of those buying the execs stocks!    Retirement Fund = Bag Holder

GMadScientist's picture

Not just the execs, but the people they've been inside trading with, playing golf with, and getting elected too.

chistletoe's picture

It seems to me so bloomin obvious that I cannot understand why wiser and more public figures are not saying it .... the whole deal with capitalism, the grease that keeps the whole system turning ... is the general expectation of growth.  In order for anybody to want to invest any money in anything, whether the vehicle is a loan or a bond or a stock or an option or anything ... he must have some general expectatiion of growth, of improvement, that things will be better after awhile than they are now that there is some reasonable hope of a profit ...


But humanity is reaching a point where, to be blunt, there are just too many fucking people on this planet, and everybody knows it ... we are reaching peak oil, peak gold, peak iron, peak coal, peak gas, peak food and way beyond peak debt ....the oceans are dying, the air is polluted, animal and plant species are going extinct by the thousands, and we are running out of enough fresh water for everybody.


Once you get to the top of Mount Everest, there is simply only one direction that you can proceed ....

Gent's picture

"But humanity is reaching a point where, to be blunt, there are just too many fucking people on this planet..."

I gotta call 'bullshit' on this!

You can fit every human being on this planet in Texas with a 1,000 sq. feet! If we would have had free markets from day one, the growth industry would be in feeding people - not investing in submarines to chase yields offered by corporate weasels so they can buy back their own fucking stock.

GMadScientist's picture

Actually no, unless you want all those people to live like their on an Indian reservation with no water. For everyone on earth to have the standard of living we assume as given in the US (because we grow up in a bubble of lies) we would need approx 30-35 earths worth of resources. For everyone to live like hippies (conserving energy, never using hairdryers, cars, etc) we will need 3.5 earths if population growth continues on the same exp curve.

We're not dire yet, but we're not addressing the future problem either.

scubapro's picture



...besides margin debt; dont forget the Securities Based Lending: