Over the course of the last several months we’ve taken every opportunity to point out the fact that undergirding the strength in equities is a wave of corporate buybacks. At nearly $350 billion, IG issuance recently hit a record for Q1 and HY supply hasn’t been too shabby either at $93 billion during the period. The supply deluge has of course been fueled by investors’ voracious appetite for anything that offers any semblance of yield in the face of a credit landscape where risk-free debt slides further into NIRP-dom with each passing month. Unfortunately, companies aren’t using the proceeds from debt sales to invest in future growth and productivity but are instead piling it all back into their own stocks, inflating both their shares and their bottom line and creating a false sense of corporate health. For more on this dynamic, see the following:
- And The Biggest Buyer Of Stocks In 2015 Will Be…
- Here Is The Reason Why Stocks Just Had Their Best Month Since October 2011
- The Biggest Threat To The S&P 500 In The Next Month: "Biggest Buyer Of Stocks In 2015" Enters Blackout Period
- Explaining US Stock And Bond Markets In 5 Easy Charts
And there are many, many more. Here are some visuals that illustrate the situation:
Now, the “very serious people” and the completely farcical people have teamed up to bring you the narrative that we’ve been pushing exhaustively. Here are some excerpts from an interview Christina Padgett, the head of leveraged finance at Moody's conducted with CNBC Wednesday on the pitfalls of re-leveraging to buyback shares:
Companies that obsessively buy back their shares could be making a big mistake, says one Moody's analyst. In fact, it may be time for corporate managers to rethink the popular buybacks and dividend hikes that improve the share price of a company without doing anything for its long-term prospects, she says.
"You have to expect that there's an inherent conflict between creditors and equity holders when it comes to share buybacks," said Christina Padgett, the head of leveraged finance at credit-rating firm Moody's, in a Wednesday interview.
Both stockholders and bondholders "believe in the long term success of the company, but there are certain benefits that go to the shareholder directly in the form of a buyback or a dividend that actually don't support future growth of the company, and so really don't inure to the benefit of creditors”...
Buybacks by S&P 500 companies rose to $219 billion in the first quarter, the highest since the fourth quarter of 2007, according to TrimTabs. Meanwhile, S&P 500 corporate dividends rose to a new record of $376 billion in 2014, according to FactSet…
"I'd like to believe that defaults are still a long way off," she said. "But my concern would be—if you think about how a company should position itself for further growth, you want to think of them as taking the cash they do have and using it to invest in something that generates growth”...
"If you think about the stock market today, it feels fairly overvalued," Padgett said.
"So you see a lot of companies buying back their shares at relatively high valuation, instead of taking that money and putting it into something more growth oriented."
Of course none of the above will be cause for Moody’s to actually make a move and downgrade any of those companies who are buying back their own overvalued stock with proceeds that should have been spent on “something that generates growth,” and while we’re happy to see someone besides us raising the alarm, we still think our take offers the most concise explanation of where we are and how it will ultimately end:
Buybacks also explain why, in the absence of the Fed, stocks continue to rise as if QE was still taking place: simply said, bondholders - starved for any yield in an increasingly NIRP world - have taken the place of the Federal Reserve, and are willing to throw any money at companies who promise even the tiniest of returns over Treasuries, oblivious if all the proceeds will be used immediately to buyback stock, thus pushing equity prices even higher, but benefiting not only shareholders but management teams who equity-linked compensation has likewise never been higher.
To be sure, this theater of financial engineering - because stocks are not going up on any resemblance of fundamental reasons but simply due to expanding balance sheet leverage - will continue only until it can no longer continue.