A few days ago, we reported that based on data by SocGen's Albert Edwards, the "buyback party was over" in which Edwards said: "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."
We have now done the math and compiled the Q2 earnings for the S&P 500 and we can indeed confirm that (at least in the second quarter) the buyback part is not only over but has ended with a thud, with the total notional amount of buybacks completed in Q2 plunging by 27% in Q2 to "only" $117 billion - the lowest since Q1 of 2013!
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Who were the biggest culprits? Why the usual suspects, namely the companies that went on a buyback spree in Q1 and have drastically cut their repurchases in Q2. The charts below show the largest repurchasers of their own stocks in Q2 and we compare these to the free for all that took place in Q1.
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It would appear that corporate Treasurers aren't all idiots after all, and with the S&P trading at 2000 (and obviously at all time highs) companies are starting to push back on buying their stock back even if the opportunity cost is the issuance of debt at ridiculously low levels.
So if corporations are no longer engaging in a slow motion LBO/MBO of the S&P 500 (courtesy of a bevy of yield chasing bond investors) the Fed has less than two months of POMO left, and retail is long gone, just who will be left buying stocks?
Then again, it could all be a temporary fluke as a result of the bond market snarling up briefly in Q2, which would have made buybacks prohibitively expensive in the quarter. With the bond bubble running on all cylinders right now, it probably is a good idea to wait until the Q3 data is in before making and conclusive observations on whether the buyback wave is over for good.
And for that and other related questions, we report the remainder of Albert Edwards' note from two weeks ago: "The Buyback Party Is Over [19]"
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!).
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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.
Source: CapitalIQ, SocGen
