U.S. companies announced $141 billion of new stock buyback programs last month and $243 billion of new M&A deals. Both figures are all-time records, and according to bubblevision are further evidence that CEOs are bullish on their companies and the economic outlook.
You might say that. Then, again, it might put you in mind of swarming moths heading for a light bulb. In his excellent post yesterday, Wolf Richter didn’t bother with the long-form chart on M&A deals since, say, the turn of the century. He just cut to the chase with this self-explanatory comparison of pre-crash peak monthly deal rates:
In a similar vein, the run rate of 2015 stock buyback announcements is on pace to reach $1.2 trillion for the full year, shattering the 2007 record of $863 billion. Yes, indeed, there is much bullish enthusiasm in the C-suite, with the weekly announcement line literally going parabolic.
The above might be taken as evidence that stock option obsessed CEOs are no better market timers than the proverbial retail mullets. As even Goldman recently noted,
Exhibiting poor market timing, buybacks peaked in 2007 (34% of cash spent) and troughed in 2009 (13%).
Right. It certainly didn’t take long to forget the lessons of 2009. Companies are on pace to put fully 28% of their operating cash flow into the buyback mill; and recall that this Goldman chart is based on gross operating cash flow before CapEx or any other investment in future growth.
Yet there is much more to this than just bad timing. The fact is, due to drastic central bank falsification of financial market prices, the C-suite temptation to bang the buyback lever—especially with borrowed cash— is overwhelming; debt is ungodly cheap and the Greenspan/Bernanke/Yellen “put” has made the equity markets a dip-buyers dream.
Consequently, corporate stock repurchases in an ever rising market mean there is never a “pause button” moment. That is, boards and executives are never forced to ask why cash flow was squandered and balance sheets were impaired to fund stock purchases at, say, 125% of today’s price.
This is the real evil of the Fed’s stock market “put”. It enables the Wall Street gamblers and robo-traders to keep the market on a seamless ascent, thereby anesthetizing the C-suite against any residual fears that pumping stock prices in order to line their pockets with stock-option winnings could unexpectedly backfire.
That hasn’t happened for 75 months now—-a time span that in today’s “snapchat” world far exceeds the institutional memory of top executives and boards.
The potency of this perverse incentive can’t be exaggerated. As Jeff Snider recently documented, the companies in the S&P 500 with the most aggressive buyback programs have experienced a 70% share price gain during the last 30-month stock surge. That compares to just 50% for the index as a whole and only 30% for the entire basket of NYSE stocks.
Therein lies the essence of our current economic malaise. In its misguided effort to make debt cheap and thereby stimulate investment, jobs and growth, the Fed is actually disabling one of the most important ingredients of capitalist prosperity. Namely, the top executive leadership of business enterprises.
In effect, the mad money printers in the Eccles Building have infected the C-Suite with a lethal addiction to stock market gambling. In all of its manifold aspects—–M&A, stock buybacks, spin-offs, asset securitizations, debt refinancings—–today’s corporate financial engineering is just a form of stock market gambling. And that’s primarily and overwhelmingly what the C-suite is preoccupied with.
It is no wonder, then, that real net investment has collapsed and remains in the sub-basement of historical trends. And here we are not talking about the monthly gross business investment numbers that the bubblevision commentariat jaws about when the number is good and excuses when it disappoints. Even on that basis, real gross business investment during the last 7 years has averaged only 0.9% annually——a far cry from historic 3-4% growth rates.
But what even this tepid growth trend omits is that as the US economy stumbles slowly forward it is wearing out its capital stock. So what counts is how much investment is being made over and above replacement of the productive assets consumed in current production, as measured by depreciation and amortization. That net investment number was $525 billion (2009$) in the year 2000—–just before business spending plunged during the tech wreck of 2001-2002.
Notwithstanding Greenspan’s manic interest rate cutting during the 30-month period after December 2000 (from 6.5% to 1.0% on federal funds) net investment in productive business assets recovered only modestly, reaching a peak of just $475 billion in 2007. What the Greenspan money printing spree accomplished, of course, was not enhanced business investment at all; it actually triggered a monumentally destructive mortgage borrowing and housing boom and bust that brought the US economy to its knees in late 2008.
During the resulting swoon, as shown below, real net business investment plunged to just $91 billion at the bottom of the Great Recession. And that was some kind of bottom. Only once (1975) during the previous 42 years had real net investment been that low.
So the subsequent gumming by Wall Street economists and their financial media lip syncers about the purportedly strong “rebound” in capital spending is just another example of the kind of context-free, ahistorical numbers scam which comprises the bubble finance narrative. Even then, the rebound in gross investment was decidedly subpar, meaning that by 2013 real net business investment had only reached $337 billion—-a level 36% below its turn of the century peak.
Moreover, 2013 was apparently close to the peak for this cycle. Since then both organic cash flow and incremental borrowings have overwhelmingly been cycled into financial engineering maneuvers. Accordingly, I estimate that net business investment peaked at about $350 billion in 2014 (not shown) owing to the fact that last year’s 6% gross CapEx increase only slightly exceeded the capital stock consumed in current production.
Stated differently, real net business investment in the year 2000 amounted to 4.2% of GDP. It then dropped to 3.2% of GDP during the next peak in 2007; and now (2014) stands at just 2.0% of GDP—-the lowest level for any non-recession year during the last half century.
Needless to say, the 15-year slump in real net investment shown above was not for lack of access to capital. In fact, US business has been on a veritable spree of bond issuance since the mid-1990s, and one that has been accelerating with each new bubble cycle.
In short, the Fed’s drastic financial repression has generated such a desperate scramble for yield among investors that the traditional function of the bond market has been eviscerated.
To wit, yield starved bond mangers, institutional investors and mutual fund chasing home gamers alike no longer give a wit as to use of proceeds from bond issues. By contrast, in the time of relatively honest financial markets under William McChesney Martin (1953-1970) and Paul Volcker (1979-1987), no respectable Wall Street underwriter or blue chip corporate board would have even considered bond issuance for the purpose of stock buybacks or serial M&A deals. The exuberant dealmakers and corporate empire builders of those halcyon times, in fact, had to use inflated stock to fund their dubious acquisitions——a form of capital raising that put their shareholders rather than their balance sheets at risk.
No longer. Companies are not only raising massive amounts of debt to fund financial engineering rather than real productive investment, they are also largely abandoning the use of stock as a currency. And that, too, is a function of the C-suite gambling culture nurtured by the Fed.
Why dilute your share base and near-term stock option payoffs when there is unlimited debt availability at after-tax costs of less than 2% for investment grade companies and 3-4% for even junk credits?
As documented in the chart below, you don’t. Even as M&A activity has soared to a $1.4 trillion annual rate, the share of deals financed with stock has dropped to just 20% compared to upwards of 50% before the turn of the century.
But wait, as they say on late night TV, there is more and its worse. The above data does not include the kissing cousin of junk bonds—-that is, leveraged senior loans. An overwhelming share of these debt tranches go into the funding of financial engineering projects, as well.
Once again, this is still another venue for misdirection by the talking heads. Their current hobby horse is that escape velocity is surely around the corner because the level of bank C&I loans has fully recovered and now stands at nearly $1.7 trillion or more than 20% above its pre-crisis peak.
Unfortunately, they are reading from their grandfathers’ Keynesian textbook. Back in the day, business recovery was indeed accompanied by rising bank loan advances to fund working capital and fixed assets. But the cyclical pattern since the turn of the century shown below is about expansion of the central bank driven financial bubble, and the financial engineering schemes which accompany it, not the expansion of business capacity to produce goods and services.
In fact, more than 100% of the $700 billion gain in C&I loan outstandings since the year 2000 represents the growth of the leveraged loan market, not the provision of traditional commercial credit.
Needless to say, the paint-by-the-numbers Keynesian commentariat cannot see the forest for the trees. What they construe as evidence of bullish confidence in the C-suite is actually proof of a profound deformation that is grinding the engines of capitalist growth and prosperity to a halt.
To wit, the equity capital base of American business is being systematically strip-minded by financial engineering from the C-suite. While the fundamental purpose of equity markets is to raise capital to fund growth, productivity and innovation, what has actually happened since the Greenspan era commenced in 1987 is just the opposite.
Over the last 27 years more than $5 trillion of net equity has been liquidated. That is, financial engineering—-especially stock buybacks and cash M&A deals—-has extinguished more equity than all the IPOs and secondary stock offerings during that period have raised. In effect, the equity markets have been transformed into gambling casinos which function to continuously ratchet-up the price of existing shares on the secondary market.
At the same time, these same central bank financial repression policies have triggered an equal and opposite spree of debt securities issuance—–more than $9 trillion. So the business sector has raised a huge dollop of net capital, but it has all been pumped into the fixed coupon section of the aggregate business balance sheet.
The chances that this 27-year long conversion of US businesses into fixed debt mules would have occurred on the free market under a neutral tax regime are somewhere between slim and none. Instead, this is state policy at work, and not in a good way.
It is no wonder, therefore, that we have experienced three stock market bubbles in the last 20 years. The Fed’s heavy handed intervention and destruction of honest price discovery in financial markets has essentially turned the C-suite of American business into a giant enterprise in financial engineering and stock market gambling.
So doing, it has diverted massive capital resources and corporate cash flows away from productive investment and into the secondary markets. There the most adept speculators and hedge funds have captured monumental windfalls owing to their ability to surf on the endless bid of the C-suite for existing shares.
But these are unearned rents pure and simple. It is no wonder that real economic growth on main street is dying and that the 1% on Wall Street are luxuriating in their billions.
The baleful truth is this. In its arrogant and misbegotten seizure of all financial power, the nation’s central bank has turned the C-suite of corporate America into a destructive agent of bubble finance. That’s ‘dumb money’ with a vengeance.