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Why A Rate Hike Might Result In A 'Double Whammy' For Mainstream Investors

Secular Investor's picture




 

Janet Yellen

After publishing ‘better than expected’ job numbers, the market interpreted the results as a sign Yellen will now most definitely increase the interest rates within the next few months. These mood swings seem to be the flavor of the day and now the futures of the 30 day Federal Reserve Funds rate are also showing an increased possibility the Federal Reserve will increase the benchmark interest rate.

We already discussed whether or not a rate hike would be a good thing for the American economy, and we were unsure about this as the recovery of the domestic economy is going extremely slow. Additionally, an increased interest rate would increase the pressure on the US budget as the interest expenses would increase by almost $200B per year per one percent increase in the interest rate.

A higher interest rate generally also means the stock market will see some cash outflows as the increased yields on bonds and savings accounts will attract the investors with a relatively low risk appetite. After a prolonged period of zero interest rate policy, there will most definitely be a repercussion for the stock markets if the interest rates will indeed increase, that's just basic economics. But there’s more.

Back in May, we reported on the extremely high level of share buybacks executed by several large companies. In the first quarter of the current financial year, approximately $400B was earmarked for share repurchases and it looks like the real number for this year will be higher. According to research from FactSet, the initial $400B has already been fully used in the first quarter of this year.

FactSet Research

Source: factset.com

And that’s quite a worrisome picture. Everything is pointing in the direction share buybacks will be responsible for $500B+ in trading volume (the TTM volume was $555B for the four quarters ending in June) and that’s quite a lot of money!

Why is this problematic?

Because for the first time since 2009, the average buyback ratio to free cash flow of the S&P 500 has increased to in excess of 100%. As most companies are also paying a dividend on top of the share buybacks, this basically means a lot of companies out there are borrowing cash to fund the buybacks. Why? Because (until now) the ability to borrow money at a low interest rate resulted in a positive tradeoff between paying more interest expenses versus boosting the per-share results.

Factset 2

Source: factset.com

In some cases, the importance of the share buybacks cannot be underestimated. Boeing was one of those ‘overspenders’, and after generating a free cash flow of $4.4B and paying out $1.9B in dividends, the company would have had $2.5B at its disposition for share buybacks in the first nine months of this year. Not bad at all, but Boeing shifted into the ‘overdrive’ mode and spent in exess of $5.6B to repurchase in excess of 36 million shares. A part of that was funded by ‘excess’ cash, another part by increasing the company’s total liabilities.

WSJ 1

Source: Wall Street Journal

So what will happen when Boeing decides it no longer makes sense to buy back shares because the economics aren’t appealing anymore as additional share repurchases would have to be funded by (increasingly expensive) debt? Its share price would no longer be supported by the buybacks, and that will indeed make a substantial difference. Buying 36 million shares for its own account in approximately 180 trading days results in Boeing having bought an average of 200,000 shares per day, or in excess of 6% of the average trading volume.

So on top of a natural shift from stocks towards fixed income assets on the back of a rate hike, a higher cost of debt will also reduce the amount of cash spent on share repurchases. As the buyback rate of the trailing twelve months is in excess of $500B, it’s increasingly likely some of the ‘heavy spenders’ (Boeing, General Motors,…)  will have to scale back their repurchase rate and the main markets would lose one of the main drivers of the recent excellent performance.

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Mon, 11/09/2015 - 10:55 | 6767269 jabhagsb
jabhagsb's picture

I don't think the consequences of 250 basis points will be so dramatic.

Mon, 11/09/2015 - 03:54 | 6766495 luckylongshot
luckylongshot's picture

Please Tyler- no more BS articles about rate rises. This song has been falsely played every month for 6 years and noone wants to hear it any more.

Mon, 11/09/2015 - 02:44 | 6766445 The best Sun
The best Sun's picture

Sure looks a lot like an engineered crash coming to me.

Imagine if you had the readies to buy up some fundamentally sound and ubiquitous commodities at the even lower prices during the coming crash event, then hold them until they spring back after a reset.

The way the Rothchilds did with the insider info. on the outcome of the Battle of Waterloo.

Just spit balling here, but imagine the USA takes a nose dive and share prices evaporate, the dollar loses reserve currency status and it's replacement (Jim Willies Shit Dollar) is valued 40% lower. Then the clued up social strata buys up say, energy distribution (poles and wires) ownership and aeronautical engineering companies and anything else that strikes their fancy. Then Elon Musk or some other gloating prick says "We have cold fusion". Would that not make those buyers the next set of world feudal overlords?

Just an example.

 

Mon, 11/09/2015 - 03:19 | 6766474 Seer
Seer's picture

Where will the buyers come from?  Yes, you can shuffle commodities between various "investment" houses, but eventually someone is going to have to buy them, and That purchase requires that there's buyers for the finished product- end-consumers.  Should be pretty obvious now that the pool of end-consumers, ones that could actually purchase things, is rapidly shrinking.

Regardless of whether they're all pricks, the risk is still there and eventually someone WILL end up eating it.

Mon, 11/09/2015 - 07:00 | 6766623 The best Sun
The best Sun's picture

In the shorter term....too true, however couldn't the workers and builders of the new industries that would spring up from the new energy paradigm provide those end consumers?

A cold fusion energy based economy would have almost no limit to electricity production and energy flux density. This would allow a complete re-tooling of practically all industrial processes and using the "fusion torch" concept of elemental production would also virtually remove the limitations of scarcity in any currently mined commodities.

Again, just spit balling with the fusion idea (though the SAFIRE project seems well on track to herald such advances if TPTB allow it).

As to who will "eat it", that will be the sheep. They always end up on the wrong side of the trade.

Sun, 11/08/2015 - 19:32 | 6765342 Tarzan
Tarzan's picture

Maybe the message has not been clearly stated.  Let me give it a shot.

Uncle Sam is Insolvent and doing everything in it's power to hide this truth!

Higher rates would expose the ponzi!

THERE WILL BE NO RATE HIKES!

Mon, 11/09/2015 - 01:44 | 6766359 Seer
Seer's picture

If you think that Uncle Sam's debts are huge then whatever you do DO NOT look at the private sector's debt!

GROWTH IS A PONZI! ROI, interest etc, it's ALL predicated on growth; when growth is no longer possible, which is a mathematical certainty (which no one wants to admit), then the SYSTEM (not just "Uncle Sam") fails.

Mon, 11/09/2015 - 14:54 | 6768680 Tarzan
Tarzan's picture

In a real free market private debt from an insolvent company goes bankrupt and dies.  Eventually the wound heals and the market is better for the loss of a weak member. If monopoly laws had been followed there would not be a TBTF private company.

More importantly, Private debt does not create money.

When money is borrowed into existence the only way to keep it rolling is growth in debt.  When the growth in debt exceeds the growth of real GDP, and thus the ability to service the debt, the ponzi eventually collapses.

The only way they can service the public debt in times of stagnant GDP is to artificially lower the cost of servicing the debt, i.e., lower interest on the debt. Talk of a rate hike is nothing more then a head fake. 

NIRP is coming, because saving money is now considered selfish and the savings of those hoarders will require they hand over their "fare share" to Uncle Sam.

It's a tax on savings and retirement accounts, something they've dreamed of for a long time!

Sun, 11/08/2015 - 17:26 | 6764963 PoasterToaster
PoasterToaster's picture

How would raising interest rates ever combat "inflation"?  Backwards ass Federal Reserve Keynsians.

Mon, 11/09/2015 - 01:48 | 6766366 Seer
Seer's picture

I'm waiting to hear from you as to what YOU think would "work."  I'm struggling to understand your (implied?) logic...

Sun, 11/08/2015 - 15:47 | 6764704 Duc888
Duc888's picture

 

 

 

WTF it a "mainstream investor"?  You're an AI algo, or you're not.

Sun, 11/08/2015 - 13:01 | 6764247 Sudden Debt
Sudden Debt's picture

This is just another populist article by a dumbed down puppet who tries to play the role of a "economist".

And the worst part is that it convinces 85% of all the momo's to believe this crap.

 

1. Why does yellen want to raise rates?

Look at history, look at the 70's rate rise. It was needed to try to contain the inflation spike. It went to over 18%! And it destroyed everything! It destroyed savings, it destroyed real estate.

Yellen, the FED needs to keep the wealth in society or their own wealth evaporates.

and inflation is popping up on every side and once it starts to spike, it's nearly impossible to contain it.

SO: A rate hike is telling us that the FED sees the first signs of out of control inflation/hyperinflation and wants to try to stem it. And now, it would actually need about 20% inflation rates to get the system back to normal, which it can't because rates can only follow inflation and not the other way arround so it always neds to be to late while to late is a bad case.

And that's why you see stocks going up, because once you see these inflation spikes, our current stock valuations will look like a joke to what they'll be in a few years.

Using the wrong numbers, populist economist say that stocks are overpriced.

Using real infaltion numbers, stocks are way to cheap. Current PE's don't matter.

 

And that's also why they suppres gold and silver because they're the canary's in the coal mine. If they would tripple overnight, people would know something was wrong and would run into real assets. By suppressing the gold and silver price, they can keep the lemmings clueless, and they're doing a very good job because most people really don't have a clue what's going on.

Hyperinflation is comming and comming fast. That's why you should buy stocks in non quick created assets like every commodity company and they've been hammered down so they're a steal right now.

Others are REIT's who invest in bonds on the long side because when hyperinflation kicks in, they're income will go nuts.

And my favorite are gold and silver. 

And avoid anything that is service or logistic related.

Mon, 11/09/2015 - 12:38 | 6767852 Vlad the Inhaler
Vlad the Inhaler's picture

People simply don't have enough money on hand to kick start hyperinflation.  For this to happen, you need panic spending, but the money has to somehow first make its way out to the population.  With 60% of households not even having $1,000 in savings, businesses already in debt, etc how could this will happen?

Sun, 11/08/2015 - 20:52 | 6765608 VegasBob
VegasBob's picture

In periods of high inflation, stocks often don't do as well as people think.  That's because companies are often behind the curve in trying to raise their prices faster than inflation, meaning that corporate margins and profits don't keep up.

Look at the US bear market from 1974-1982.

Will it be different this time? Who knows?

Between housing costs and Obamacare, there's no longer much of a middle class in this country that has the ability to ratchet up spending in response to rapidly rising prices.

Sun, 11/08/2015 - 13:10 | 6764280 Truth Eater
Truth Eater's picture

Buy stocks now?  Hmmm...  not sure that is such a good idea.  They have been pumped for 7 years to create the illusion of wealth.  All the while there has been a deflation wave building.  Even at zero interest, there is no stomach for new debt.  Without new debt there is no inflation.  Hyperinflation?  What mechanism do you propose will put money into the hands of the people, the consumers who will drive this?  No, they do not want people to have money.  They want people to have debt.  They want chaos and destruction so a new world order can be given a new birth.

Sun, 11/08/2015 - 12:58 | 6764227 Truth Eater
Truth Eater's picture

Market capitalization is an illusion.  It pretends that all stocks of a company are of equal value.  In a sell-off with few buyers, prices begin to drop.  Only the first to sell receive the expected value of the capitalization rate.  All others see a deflating balloon.  This is why the PPT keep tight controls on the market- ready to pump main index stocks to maintain the illusion.

 

At some point there will be a crisis that neutralizes the PPT.  When that happens, pandemonium will break out like rats from a sinking cargo ship.  By then the ship will be far out at sea and alone.

Sun, 11/08/2015 - 12:01 | 6764057 InnVestuhrr
InnVestuhrr's picture

Impoverishing Effect (raising rates after 7 years) = Wealth Effect in reverse(after massive QE + ZIRP for 7 years)

None of the central bankers, ie market manipulators, are portfolio managers, I am. Regardless of their motivations and intentions, there is one very critical factor that they have not taken into consideration in their models and policies.

Assume for the moment only that it is OK to have a central bank with the power to manipulate the interest rate market, with the intention of using that power only in a very minimalist manner, only in a time of financial and economic crisis, eg sudden huge financial market sell-offs, natural disaster, sudden steep decline in economic activity, widespread bank runs, etc. Then a reasonable argument could be made for artificially driving interest rates to low levels for a very brief time only just to slow and stop the financial and economic collapse, ie an emergency mechanism ONLY.

BUT if interest rates are artificially driven to low levels for 7 years, THEN the result is that the entire financial and economic system is FORCED to adapt, conform, and come to a new stasis around the artificially low interest rates.

What that means in practical fixed-income portfolio management terms is that ALL the fixed-income portfolios will be loaded up with the fixed-income assets that HAD TO BE purchased during the insanely recklessly looooooooooooooooong pseudo "emergency" period of crushed interest rates, ie at very highly inflated prices and very low yields. This is because individual and institutional financial and economic activity cannot stop and wait unspecified years until after the interest market manipulators stop crushing interest rates, whenever that may be, because the "emergency" period is FAR TOO looooooooooooooooong. So retirees, insurance companies, pension funds, endowments, banks, etc, all of whom are required to invest in fixed income assets because of their situations and business models, are forced to buy those fixed-income assets at absurdly artificially high prices and low yields.

So if the interest market manipulators then raise interest rates, fixed-income asset prices will fall, and all of the fixed-income portfolios of retirees, insurance companies, pension funds, endowments, banks, etc, who were forced to buy the artificially high priced assets during the 7-year long "emergency" period are going to have LARGE unrealized losses. All of these portfolio owners are then going to be impoverished, and will have to hold their fixed-income assets to maturity to avoid selling at much lower prices and incurring large real losses. This will have a stifling effect on all of these portfolios and owners, and could be a problem for many of them, eg retirees who need cash to cope with illness, or insurance companies who need cash to pay for natural disaster claims, pension funds who need cash to pay for the tidal wave of retirees, etc

So wealth effect created by pushing interest rates down is replaced by impoverishing effect as the interest rates are raised.

Mon, 11/09/2015 - 11:51 | 6767573 ebworthen
ebworthen's picture

You walk into the casino with your wallet full, you leave with it empty.

Mon, 11/09/2015 - 03:19 | 6766472 honestann
honestann's picture

Correct statement of what happens, BUT... the reason that happens is because those who made bad decisions and operate inefficiently continue to operate, continue to make bad decisions, and continue to operate inefficiently.

Those huge numbers of folks who got screwed (as you described) had the wealth they would have earned stolen and misdirected to those who made the bad decisions and operated inefficiently.

The worst part of this scenario is... the process of creative destruction is thwarted.  Since those who make bad decisions and operate inefficiently are not weeded out, every penny the consume, and every hour their employees work is stolen from what would have replaced those "bad/inefficient actors"... new blood, so to speak.

And so, the entire natural process of "ever increasing efficiency" is destroyed.  In fact, it is replaced by "ever decreasing efficiency"... which means the overall quality of life FALLS.

Of course the most unjust part of the whole process is this.  While the overall quality of life FALLS, it does not fall evenly.  Those who manipulate the strings to prevent the natural collapse (which should be called "cleansing" instead) end up becoming super-rich at the expense of everyone else.

And so, trying to interfere with natural market consequences... even just a little bit... unavoidably causes bad/inefficient actors to get better results, and good/efficient actors to get worse results.  That is a sure way to destruction, which is what is coming to a planet near you very, very soon.

Mon, 11/09/2015 - 08:23 | 6766711 Wow72
Wow72's picture

Thats exactly it... by keeping it going  they make it ten times worse and they should have enough intelligence to know better, but they dont.

Sun, 11/08/2015 - 12:47 | 6764191 the grateful un...
the grateful unemployed's picture

good point the war on savers has just started, rising rates are even more punishment. i feel the fed didnt do the right thing in the first place, the fed goal of a stable market implies setting interest rates at a level which reflects the level of risk in the market. clearly risk was very high, but they lowered rates. now do two wrongs make a right? does raising rates when risk is low make sense? well a long time ago Wayne Angell made the comment that lowering rates only acerbated deflation. its that true then raising rates may turn the economy into hyperinflation, which is often what you get at the end of a deflationary crash. i think the fed was trying to manage deflation by playing along, lowering rates, trying to avoid the deflationary cycle. i feel either way, if we get a brief period of NIRP it will be a springboard to higher than normal rates, and this was the purpose of all the reverse repo they did in september. reverse repo gives them greater control they become the lender of first and last resort. if there is brief period of NIRP and then hyperinflation WITHOUT guidance or transparency from the Fed investors will get slaughtered.they have all become programmed to accept incrementalism from the Fed, not volatile swings and reversals.

Mon, 11/09/2015 - 01:37 | 6766354 Seer
Seer's picture

I think that the "war on savers" has been going on for quite a while now.

Without actual, organic growth there is nothing that will keep it all from imploding.  Everything is premised on growth, perpetual growth.

It's a slow death via bleed-out of the  "consumer" class.  The trajectory was always that the exponential increases in consumption would hit a wall.  The Fed et al have been trying to keep the status quo going because the system cannot do anything other than "status quo."  Bleeding the consumers (sucking out savings, falling wages etc) was the "soft landing" approach, over that of a big sector piece collapsing due to margin calls (collapsing derivatives).

So, yes, fixed income will get hammered.  There's no other source of digits available to plug the holes with.

I'd also thought that many companies were using their own cash to buy their stock in an effort to break away from  the Wall Street Casino.  When viewed this way the strategy makes perfect sense, except for the issue of consumers being in decline.  Yeah, either get caught up landing on the wrong number on the Casino's Big Wheel and have the business fold or fight the bleed-out as scales of economy start reversing and end up closing you down due to insufficient margins.

The seed corn -future- is being eaten.  Starve to death today or starve to death tomorrow.  Choose wisely!

Mon, 11/09/2015 - 12:51 | 6767926 the grateful un...
the grateful unemployed's picture

the consumer class is everything (compare this to ancient egypt where there were no consumers, just workers) then Moses led them to the promised land, and some sort of prophet will lead consumers out of this trap they have us in, infinite debt, infinite consumption. i think consumers are getting burned out, like a kid with too many toos at christmas, starts playing inside the empty boxes. i think people will tire of consuming and the psychological shift will be too much for the corporate world to adapt. and once food shelter and transportation are ubiquitious and nearly free things change.

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