The Trump administration is putting together a rumored trillion-dollar-plus stimulus package that will include taxpayer funded bailouts of Corporate America, according to leaks cited widely by the media. Trump in the press conference today singled out $50 billion in bailout funds for US airlines alone. A bailout of this type is designed to bail out shareholders and unsecured creditors. That’s all it is. The alternative would be a US chapter 11 bankruptcy procedure which would allow the company to operate, while it is being handed to the creditors, with shareholders getting wiped out.
So get this: The big four US airlines – Delta, United, American, and Southwest – whose stocks are now getting crushed because they may run out of cash in a few months, would be the primary recipients of that $50 billion bailout, well, after they wasted, blew, and incinerated willfully and recklessly together $43.7 billion in cash on share buybacks since 2012 for the sole purpose of enriching the very shareholders that will now be bailed out by the taxpayer (buyback data via YCHARTS):
Share buybacks were considered a form of market manipulation and were illegal under SEC rules until 1982, when the SEC issued Rule 10b-18 which provided corporations a “safe harbor” to buy back their own shares under certain conditions. Once corporations figured out that no one cared about those conditions, and that no one was auditing anything, share buybacks exploded. And they’ve have been hyped endlessly by Wall Street.
The S&P 500 companies, including those that are now asking for huge bailouts from taxpayers and from the Fed, have blown, wasted and incinerated together $4.5 trillion with a T in cash to buy back their own shares just since 2012:
And those $4.5 trillion in cash that was wasted, blown, and incinerated on share buybacks since 2012 for the sole purpose of enriching shareholders is now sorely missing from corporate balance sheets, where these share buybacks were often funded with debt.
And the record amount of corporate debt – “record” by any measure – that has piled up since 2012 has become the Fed’s number one concern as trigger of the next financial crisis. So here we are.
In 2018, even the SEC got briefly nervous about the ravenous share buybacks and what they did to corporate financial and operational health. “On too many occasions, companies doing buybacks have failed to make the long-term investments in innovation or their workforce that our economy so badly needs,” SEC Commissioner Jackson pointed out. And he fretted whether the existing rules “can protect investors, workers, and communities from the torrent of corporate trading dominating today’s markets.”
Obviously, they couldn’t, as we now see.
Enriching shareholders is the number one goal no matter what the risks.These shareholders are also the very corporate executives and board members that make the buyback decisions. And when it hits the fan, there is always the taxpayer or the Fed to bail out those shareholders, the thinking goes. But this type of thinking is heinous.
Boeing is also on the bailout docket. Today it called for “at least” a $60-billion bailout of the aerospace industry, where it is the biggest player. It alone wasted, blew, and incinerated $43 billion in cash since 2012 to manipulate up its own shares until its liquidity crisis forced it to stop the practice last year, and its shares have since collapsed (buyback data via YCHARTS):
If Boeing’s current liquidity crisis causes the company to run out of funds to pay its creditors, it needs to file for chapter 11 bankruptcy protection. Under the supervision of the Court, the company would be restructured, with creditors getting the company, and with shareholders likely getting wiped out.
Boeing would continue to operate throughout, and afterwards emerge as a stronger company with less debt, and hopefully an entirely new executive suite and board that are hostile to share buybacks and won’t give in to the heinous clamoring by Wall Street for them.
No one could foresee the arrival of the coronavirus and what it would do to US industry. I get that. But there is always some crisis in the future, and companies need to prepare for them to have the resources to deal with them.
A company that systematically and recklessly hollows out its balance sheet by converting cash and capital into share buybacks, often with borrowed money, to “distribute value to shareholders” or “unlock shareholder value” or whatever Wall Street BS is being hyped, has set itself up for failure at the next crisis. And that’s fine. But shareholders should pay for it since they benefited from those share buybacks – and not taxpayers or workers with dollar-paychecks. Shareholders should know that they won’t be bailed out by the government or the Fed, but zeroed out in bankruptcy court.
The eventual costs of enriching shareholders recklessly in a way that used to be illegal must not be inflicted on taxpayers via a government bailout; or on everyone earning income in dollars via a bailout from the Fed.
The solution has already been finely tuned in the US: Delta, United, American, and other airlines already went through chapter 11 bankruptcies. They work. The airlines continued to operate in a manner where passengers couldn’t tell the difference. The airlines were essentially turned over to creditors and restructured. When they emerged from bankruptcy, they issued new shares to new shareholders, and in most cases, the old shares became worthless. The new airlines emerged as stronger companies – until they started blowing it with their share buybacks.
Companies like Boeing, GE, any of the airlines, or any company that blew this now sorely needed cash on share buybacks must put the ultimate cost of those share buybacks on shareholders and unsecured creditors. Any bailouts, whether from the Fed or the government, should only be offered as Debtor in Possession (DIP) loans during a chapter 11 bankruptcy filing where shareholders get wiped out.
In other words, companies that buy back their owns shares must be permanently disqualified for bailouts, though they may qualify for a government-backed DIP loan in bankruptcy court if shareholders get wiped out. Because those proposed taxpayer and Fed bailouts of these share-buyback queens are just heinous.
Transcript00:01SVEN HENRICH: Sven Henrich, been running Northman Trader for about six years.00:05Originally, private investors, way background was corporate management actually in corporate00:10strategy internationally, always been looking at companies and opportunities.00:14Hence, the background and analyzing stock markets comes natural to me.00:19Our business model is really looking at identifying the big moves.00:24We’re not day traders where we’re looking at swings, so be it long be short.00:27Of course, as part of that, we’re looking at the macro environment markets in general–00:32central banks, what have you, although that’s secondary, the key is technicals and being00:38able to identify the big turns and that’s what we do.00:41You see me on Twitter, @NorthmanTrader or on the website, northmantrader.com.00:48Yeah.00:49In April, I had put out a piece called, “Combustion”.00:55It was this whole notion that both bulls and bears need to be mindful of potentially this01:01really uplifting scenario.01:02We had a big turn from the lows of 2018.01:06We’re literally all central bank policy combusted by them and the view was we’re going to be01:11raising rates, we’re going to be having a reduction in the balance sheet on autopilot.01:15Then of course, markets dropped 20% and then yields dropped, actually started the other01:21way around.01:22Basically, it was yields heading to 3.2% on a 10-Year in October, and that sparked a whole01:27selloff in my mind, but basically, central bank’s completely reverted policy.01:33The Fed had this whole job owning operation all year long from tightening to easing and01:39rate cuts are coming.01:41That’s what they’ve been doing all summer long.01:43In April, what I said was we’re going to keep going on this trajectory until something breaks.01:50We had a quick correction in May, we had some of the same negative divergences that we have01:56in the fall.01:57Something interesting happened here, because we had a temporary high and then we had the02:03correction.02:04Then in July, we came to a new high and we had a correction.02:08In June, actually, I had put out this piece called, “Sell Zone,” this was at the end of02:12June, just before the Fed meeting in July, and the notion was this period, this price02:18zone between S&P 3000 to 3050 is a sell zone, listed a whole bunch of technical factors02:24for that.02:25We had the initial reaction.02:26It was coming off the heels of the Fed rate cut, the first rate cut since the financial02:30crisis.02:31We dropped from 3028 down to about 2780 on the futures contracts.02:37A snappy technical reaction.02:39Then it all started again with trade optimism and more rate cuts coming and so we rallied02:45again into September.02:47My view in April was that would be this potential for a blow off top move and the ultimate target02:54of that was about 3100 as an extreme case.02:59Now, what I find interesting here is that in September, we got back to this 3000 zone03:05that I had identified at the end of June as a sell zone, 3000, 3050.03:10We got another rate cut.03:13The ECB cut, and we got to 3022, just below the July highs and we dropped again and so03:21now we have to rate cuts, two drops, potential for double top because we have these all new03:28highs up and sold in the last year and a half.03:31There’s not been yet evidence that any new highs are sustainable so markets have been03:35this wide range.03:38In 2019, primarily driven by multiple expansion, either by trade optimism, or by the Central03:45Bank put and my question in general has been, what’s the efficacy?03:49Is there a sign that central banks will actually start losing control of the price equation?03:55We’re at the edge of control here.03:57We’re still in this phase here with the China trade negotiations.04:02Global macro has been slowing down throughout the year, the US was the island and the sun,04:08if you will, because global markets actually peaked in January of 2018 and then the US04:13decoupled from the rest of the world.04:15Europe, very close to a recession here.04:19The manufacturing data is maybe now spilling into the services sector.04:24There is now risk that we’re ultimately going into a global recession into 2020 and what04:30central banks obviously, have clearly stated, their intent is to extend the business cycle04:36by any means necessary, and we can talk about that separately.04:40We’re now at this critical point.04:42Will we get a trade deal that’s substantive?04:45By substantive, I mean that actually impacts CEO confidence.04:51Keep in mind, this whole year and a half year with this trade war going on, companies have04:57been holding back on CapEx investments, business investments, and now, we’re seeing a slowdown05:01in hiring.05:02Remember, with a 50-year low in unemployment, the official unemployment rate, and jobs growth05:08has been slowing down.05:11If you get a– and I’ve been very consistent on this, if you get a substantive trade deal05:16that addresses all the big issues and causes companies to say, “Okay, now we’re more confident05:21again,” then yes, you can have a massive blow off rally and now, with easing central banks05:28and the oldest liquidity coming in, you can have that run.05:31The question is, are these parties really in a position to say we’re going to have a05:36substantive trade deal?05:38There does not appear to be any sign of that whatsoever.05:41We see a lot of positioning, actually this week even, we see China in the US aggravating05:47the tactical battle, if you will.05:49China is– in this morning’s indicating they may be open to a partial deal.05:53What does a partial deal really mean?05:56Is there probably a relief rally surrounding a partial deal?05:59Probably.06:00We can all speculate in the sense that, “Okay, well now, it’s not going to get any worse.”06:05It’s a stalemate.06:07We’ve basically, everybody’s waving the flag.06:10Mr. Trump wants to get reelected in 2020.06:13Can’t afford a recession.06:14The Chinese don’t want things to get worse either.06:17Everybody’s holding back.06:18Fair enough.06:19That could happen, but is it enough to then get confidence back to say, now, we’re ready06:24to invest when the big issues remain unsolved?06:29That’s obviously the question that no one can answer.06:31Now, of course, the flip side to this is there’s not enough that the parties either can agree06:38to that gives anyone any confidence because keep in mind, all the slowdown has perpetuated06:44in the last year and a half.06:47There has not been any sign of slowing down, maybe a little bit civilization in China but06:51now, the US is slowing down.06:53In fact, I think it was the Fed’s Rosengren that came out last week, and says he’s expecting06:571.7% GDP growth for the second half of the year in 2019.07:03Not exactly convincing when you have a market that has rallied on nothing but multiple expansion07:09in 2019.07:10There’s a lot of risk both to the upside and the downside from my perspective.07:19On the one hand, yes, there’s some similar elements.07:21On the other hand, people like to say it’s different this time.07:24Well, it really is different this time because, look, in the past, we’ve had situations where07:29we’ve had high debt, and we’ve had yield curve inversions, we had all these things that are07:33taking place at the end of a business cycle, but never before have we seen so much intervention,07:40so much jawboning and never before have we come out of a business cycle where central07:46banks have not normalized in any shape or form.07:50This is uncharted territory.07:53I think we’re all– I don’t know what the expression is so maybe we’re all mollified07:59or pacified in a way because markets have changed so dramatically over the last 10 years08:06as a result of permanent central bank intervention.08:09I get it from any investor perspective, because we’ve all been trained, literally trained08:16to know that any corrective activity in markets is contained.08:23It’s contained within a few weeks, within a few days, within a few hours.08:28All bad news is priced in immediately.08:31We saw it in December.08:33This was the most substantial correction we’ve had since 2011.08:37Why did that happen?08:38It stopped right when Mr. Mnuchin came in with his liquidity calls to banks and with08:43Mr. Powell flipping policy on a dime.08:46We’re flexible suddenly.08:49This is this point where you never have anything that sticks from a price discovery perspective.08:57My concern in general and the voices in the summer was that we’re creating these markets09:03that disconnect ever farther from the underlying size of the economy.09:09Well, there’s two trains of thoughts.09:14First of all, this is a history part of it.09:18History actually tells us that the inversion we have on the 10-Year and the 3-Months actually09:22precipitates a recession every single time.09:25The question is the timing of which.09:27Now of course, you have other yield curves.09:28Some of them which are inverted, some of which are not, but it’s really the point of the09:34steepening.09:36Once that inversion reverts back into a steepening phase, that’s when usually the recession comes.09:42We’re not at the point yet where that steep learning has taken place.09:46However, the 10-Year and 3-Months, it’s been inverted for several months now and that’s09:51typically one of these classic warning signs.09:55There’s another school of thought that says basically, well, none of this matters anymore10:00because we have central banks intervening and blah, blah, blah, blah, blah.10:03I’m not of that viewpoint.10:06I think the signals are there.10:09What’s missing for the bear case, frankly, as I called it the missing link is the fact10:15that unemployment is still okay.10:18There’s not been a minute where it’s been slowing.10:20We haven’t seen that flip yet, where companies are suddenly really going into layoff mode.10:27That’s what interesting looking at Q3 earnings now, because a lot of companies will show10:34either flat or actually negative earnings growth, which brings me back to this multiple10:38expansion.10:39We’ve been running to market highs, not because of great earnings growth.10:44Earnings growth is flat to weakening here in this quarter and so companies are experiencing10:51margin compression.10:52Then there is that point where they want to start looking at the largest expense line10:58item, which is jobs.11:03What’s been so interesting and the reason I kept saying that all new highs are sells11:08is because all these new highs are coming on specific technical signals and sector divergences.11:16Especially looking at this year, again, we see– well, last year was basically again,11:22this was tech, it was Fang-led.11:24It was the big tech companies.11:27All new highs came on negative divergences on the technical basis and they were sells.11:31What was interesting, ever since 2018, the markup of the market has radically changed.11:37Last year, the banks were leading, the small caps were leading, right into these September,11:43October 2018 highs.11:45That has completely changed in 2009.11:48You overlay a chart with the SPDRs vis a vis small caps and transports and the banking11:53sector, it’s a horror show.11:56When we’re looking at the S&P like in September and again, within all-time highs, I can tell12:00you if you go back to exactly last year, the banking sector small caps and transports,12:06they’re all down to 11% to 13%.12:09They’ve not participated.12:10In fact, they’ve been in months long ranges.12:15It’s amazing because you see these rallies go up as and hey, people get bullish again.12:20Then they drop right back to the bottom but the bottom is holding.12:24Even this week, again, the small caps, transports and the banking sector, right on the edge12:28of support and they keep bouncing.12:30Now, I look at this from a technical perspective, I say, “Okay, well, the more often you tag12:35a certain area, the weaker it becomes either to the upside or to the downside.”12:40We’ve tagged these areas now multiple times and for a rally to convince, for new highs12:47to convince and to be sustainable, we need to see those sectors partake and get above12:54resistance.12:56Until I see that, I’m very suspicious of any new highs if we get new highs and from my13:04perspective, going back to this whole trade deal, unless we see a substantive trade deal,13:09I view any rallies to new highs as sells because that’s basically what they’ve been doing.13:15Just one more thought on this whole sector piece, there’s a chart I’ve been publicizing13:20quite a bit that’s called the “Value Line Geometric Index.”13:23It’s a fascinating technical indicator because all these indexes are market cap based.13:30The Microsofts, the Apples, the Amazons obviously have a dominant impact on an index like the13:36QQQ because they’re worth a trillion bucks each.13:40If you take all the stocks and put the same dollar value on them, let’s say everyone is13:45worth 100 bucks, and now track their relative performance, you get a completely different13:50picture.13:51What we’ve seen since 2018, since the September 2018 highs, is that all new highs that were13:57made on the S&P come on the lower reading on the value line geometric index.14:03That’s another one of those signals that tell you, “Okay, these new highs have been a sell.”14:08See that picture change, then you can have sustained new highs.14:12To me again, it comes all about efficacy of what the central banks are doing whether we14:16get a solid trade deal or not.14:18Because in so far, none of these things have shown any impact or suddenly changing the14:24growth equation in the economy.14:31Volatility has been fascinating.14:32I’ve been publishing quite a few pieces on the VIX in the last few months.14:37The VIX, I hear this all the time and I keep having to push back.14:42People are saying you can’t chart the VIX because it’s a mathematical derivative product.14:47Yes, you can chart the VIX.14:49In our job, what we do, obviously, we always have to look for what is relevant.14:55We can all have our opinions.14:58What markets should do or shouldn’t do, they will do what they will do and what we have15:04to do is keep ourselves on this and to see what is relevant.15:07We know a lot of algorithmic trading is part of markets.15:12They follow programs as well.15:14You always have to look at, “Okay, what are they looking at?15:17What are they sensitive to?15:19What are they reactive to?”15:20Because we want to be able to interpret risk reward short or long on that basis as well.15:27What the VIX has done over the last two years is fascinating.15:30There’s been very specific what I call compression patterns in the VIX, especially on the low15:36end.15:37It can drive people nuts.15:38It can get caught, consolidate on the low end and then boom, you have a spike.15:44That seemingly comes out of nowhere, but it doesn’t.15:48It’s in the charts.15:49I call them these compressing wedges.15:53Now, what’s been happening on the big picture on the VIX is as the S&P has made new highs15:58each time, the VIX and the in between periods has made higher lows.16:03There’s a trend of rising volatility.16:06Obviously, December last year was the big spike.16:10It’s the lows, what happens during the lows?16:13Remember, 2017 was the most volatile compressed year ever because we had global central bank16:19intervention, we had the upcoming tax cuts, there’s no volatility markets from a trading16:25perspective, I hate that.16:26I love volatility, I want to see things move, but now that we’ve had these selloffs, even16:32the smaller ones, if not been able to contain volatility to the extent that they’ve been16:38able to do in 2016 and 2017, since 2018, we have a trend of higher lows.16:46Now, the VIX is again in a compression pattern that suggests the possibility of a sizable16:52spike still to come this year so we may have one more hurrah before the yearend rally that16:59we so often see in markets.17:05I think this whole shift of passive is fascinating.17:08Maybe a couple of comments on that.17:10I haven’t seen this discussed anywhere.17:12Just my impression.17:13I’m wondering how much of the shift from active to passive investment is actually a consequence17:20of central bank intervention.17:23What is driving passive?17:24Well, you talk about management fees on the active side.17:27Well, the main driver for the movement to passive is that people have given up.17:32They see active investors lagging the indices.17:35Why are they logging the indices?17:37Because everything is geared towards the big cap stocks.17:41The intervention– if you’re really careful in analyzing and you’re smart and you have17:46a smart team, if you diversify in the universe and you get hammered anywhere you lag in the17:54indices, and passive allocations keep allocating passively.18:00It’s like this dumb machine that doesn’t care how much it pays.18:05It doesn’t care what the valuations are, doesn’t care about any of that.18:11To your point about signaling, yes, it’s amazing when you see– and that’s why I’m coming from18:16a technical perspective, you see charts that are massively, massively historically overextended18:24but no one cares because you have this passive machine that keeps investing.18:28I think I mentioned this last year, too, it’s like, are people actually aware what they’re18:33competing with?18:35Because you and I may have a sense of, “Okay, this is getting very expensive,” but a machine18:42doesn’t care what it allocates.18:44The ETF doesn’t care what it allocates.18:47It just has to do rule based.18:51You’re sitting in the market with entities that don’t care if they overpay.18:57Classic example is Apple.19:00Take that stock as an example.19:03It’s obviously hugely valued.19:05It’s a big company.19:07It’s a trillion dollar valuation, but it keeps buying back its own shares.19:12Obviously, as a big company, it benefits from these passive allocations.19:16What people don’t realize is that Apple has the same amount of earnings that it had in19:242015.19:25Four years later.19:26Absolutely no change in earnings, same amount of earnings, but people are paying almost19:29twice the price for the same stock.19:31Why?19:32Because Apple’s been buying back its shares, therefore reducing the float and save for19:37the same amount of earnings produced a much higher EPS, earnings per share, bigger.19:43It looks like it’s growing, but it’s not.19:45That’s my point about this whole pacified machine that has been created.19:52You, since corrections are not allowed to take place for an extended period of time,20:00you’re looking at all of sudden at yearly charts.20:03We have stocks, as I mentioned before, like a lot of sectors are lagging behind, and the20:09big cap stocks keep holding everything together because all the money goes towards them.20:15Because corrections are so short, we have yearly charts that show nonstop gains for20:2310 or 11 years.20:26There’s absolutely– the December corrections even show up in these charts because they20:30were still up on the year in many cases, so you look at Starbucks and Disney.20:36Disney is a good example.20:37Up 11 years in a row.20:39Well, this is this fantasy that’s being propagated now.20:43Because I just put my money into passive funds, I don’t have to think about it.20:47It’s risk free central banks always intervene and so we have these massive charts that are20:52vastly extended.20:53Even the technical indicator I watch.20:56On any chart timeframe, you will find this useful.20:59Be it on the daily chart, the weekly, the monthly, the quarterly and the yearly, it’s21:03the five exponential moving average.21:06Even on a daily chart, you see vast extensions above it, it will reconnect either to the21:12upside or the downside.21:14If you see massive extensions on the weekly chart, at some point, it will reconnect.21:19The reason I mentioned this is there are stocks like Microsoft that are 50% above the yearly21:27five EMA.21:29Why is that relevant?21:30Because if you look at the history, look at a stock like Microsoft, you can go back to21:35its inception and this stock always connect every single year like clockwork.21:42There were two exceptions, Microsoft, my favorite example.21:47One was the year 2000.21:48It was in 1999.21:50It was completely extended, did not touch the fire a yearly five EMA.21:54Then the second year was 2001 when it went way above, and then it obviously plummeted21:59down with the NASDAQ crash and reconnected, and now.22:04It’s now on its second year, it hasn’t even touched it.22:06It’s vastly extended.22:07From my perspective, I look at all this with what central banks are doing here.22:12I see risk building that these reconnects, technical reconnects, will take place at some22:19point.22:20When they do all of these stocks all of the sudden have 30%, 40%, 50% downside risk.22:28This is the undiscovered country.22:30It really is.22:32Look, I’m coming from a training perspective.22:35I’m resentful of central banks simply because of the volatility compression that they have22:40aimed to do.22:41In fact, Jay Powell came out yesterday, made a very telling statement with regards to repo22:47and overnight money markets.22:49He literally said we have to calm markets down.22:52We need to calm.22:54Where’s that in your charter?22:55Where’s that in your job description to calm markets down?23:00Look, markets are supposed to be free flowing in price discovery, but it’s telling because23:04he has to control that aspect of the interest rate equations, he has to control it.23:10That’s the point.23:11Everything is controlled.23:15When I look at this experiment that has taken place over the last 10 years, and I’m just23:21absolutely flabbergasted that this is not being pressed more critically by journalists,23:27by the media and by the public discourse.23:31QE, lower rates were emergency measures to deal with a crisis.23:37That was the original intent.23:39Ben Bernanke, QE1.23:42Then came QE2, and then twists and turns, then QE3.23:48It morphed into permanent intervention.23:51The promise was always we’re going to normalize, becoming come out of financial crisis, everything23:57that we do, low rates were going to incentivize growth in the economy.24:03They haven’t.24:04It was the slowest growth recovery in history.24:06In the meantime, low rates have enabled this incredible debt expansion.24:12Now, we also got eyes always glaze over with debt no one even– the numbers have gotten24:17so big and continue to get ever larger that no one even can fathom these numbers.24:22Here’s a fun one.24:23In the last 10 years, the US has added more debt to its balance sheet than in the previous24:3142 years combined.24:32That’s this vertical curve we have and there’s no end in sight.24:37When the Fed, last year, tried to normalize its balance sheet and try to raise rates,24:45which they managed to get to, basically, the lowest point of raising ever, it all fell24:52apart.24:53The 10-Year hit 3.2% in October of 2018.24:58That was the end of it.24:59The debt construct cannot handle higher rates and so they were forced to capitulate.25:05My question and the answer to your question is, can they keep this going forever?25:10Which is interesting to me, coming back to this point I made earlier about valuations25:14of asset prices vis a vis the underlying size of the economy.25:19In the year 2000, when the NASDAQ bubble burst, the overall market cap of the stock market25:26got to about 144% of GDP.25:28That was it.25:31It was just too high above the economy.25:35That’s where the crash happened.25:36That’s where the recession came.25:39Then we re-inflated.25:40This was the lead up to the housing bubble.25:43Cheap money, who caused the housing bubble?25:46Well, we can argue it was the Fed with cheap money and this cheap money had to go somewhere25:51and so we offered credit and subprime mortgages to people who can’t really afford it.25:57The stock market rose to about 137% of GDP.26:02Guess where we topped in January of 2018?26:06144% market cap to GDP.26:09Where did we top in September of 2018?26:13146% stock market cap to GDP.26:16Where did we end this summer in July?26:18144% stock market cap to– there seems to be this natural barrier that says, “Okay,26:24well these valuations have to be justified somehow.”26:29When I now see the Fed saying, okay, well– back in September, where we’re back at 144%,26:35what are you trying to do here actually?26:38Obviously, what you have done, what all the central banks have done has not produced organic26:44growth anywhere near the growth that we’ve seen in previous cycles.26:50That’s why the ECB still in negative rates and they’re trying to do more than negative26:53rates.26:54For me, that the question is one of control, efficacy.27:00Does this produce another lasting jumping an asset prices?27:05There is no answer to that question yet, but there may be signs.27:10For me, the first sign was, okay, this July rate cut when we had that sell zone of 3000,27:163015.27:18Does the Fed rate cut actually produced sustainable new highs?27:21The answer to that was no.27:24Then in September, we had the second rate cut.27:26Did that produce sustainable new highs?27:28No.27:29Yesterday, Jay Powell talked about increasing the balance sheet again, but don’t call it27:36QE, wink, wink.27:38We sold off.27:41Those are those three specific signs, events where the Fed has not succeeded in producing27:48new market highs or for that matter, new growth.27:53I think the question is very much outstanding.27:58Once we know what’s happening with this trade deal, we need to keep reassessing the mechanics28:02of markets and the technicals and see if we can actually see a sizable turn in the economy.28:09I’m highly skeptical.28:12Because all we’re doing is just keep enabling more debt and demographics are not changing28:20as a result of that.28:21The deflationary cycle is not changing as a result of that.28:25Beyond temporary highs, I have to see where that’s producing anything on the macro form,28:32and so far, it hasn’t.28:36I think we have to differentiate two things.28:40The MMT part, it’s your classic capitulation.28:44We don’t know how to solve any of the world’s problems, because that equation is ongoing.28:51Because we have demographics that are sending a very clear signal.28:57Working age population, by the way, I’ve posted out a few times.28:59I find it fascinating.29:01For the first time ever, the growth in working age population is actually going negative.29:06That tells you everything you need to know.29:08There’s a huge demographic change going on as the baby boomers were retiring, how do29:13you produce growth with those numbers, unless you believe in some AI productivity fantasy,29:20which we don’t have evidence for that yet.29:25MMT to me is the ultimate absurdity of it all.29:32Free party, free credit.29:34We keep printing money and there’s no consequences.29:37MMT adherence will obviously push back hard on this, but even central bankers like Jay29:44Powell are very much opposed to MMT.29:47I personally think is a fantasy, as well.29:50In terms of your question about fiscal policy, can now governments come up with infrastructure29:58programs or what have you to really push that equation?30:03This is where I’m going to have a different take on everything.30:06Now, this brings me back to what we’re seeing in the political sphere in the United States30:10and the United Kingdom, in Germany, everywhere across the west.30:14We have social fragmentation, the likes we haven’t seen in our lifetimes, at least.30:24It’s hard to see political cohesion anywhere.30:28Germany, for example, used to have three or four parties, not a six, seven and no one30:33has a majority of any sort.30:36The UK Brexit is a classic example.30:40It’s impossible to come to any agreeable solution that’s been going on for years.30:46The United States is, impeachment aside, what’s happening down that front, this fragmentation30:54has been going on for at least 20 years.30:56It just keeps getting worse and worse and worse, and how do you get to a complex policy31:03solution that enables you to actually implement structural solutions if you can’t agree on31:10a common reality, and there’s no common reality on anything right now.31:15Although to be fair, Democrats and Republicans in the US always agree to spend more money,31:20that’s what we just saw again in this latest budget round.31:24I remain unconvinced that fiscal– even though I hear Draghi claiming for more fiscal spending,31:33I don’t see the political cohesion to bring something like that about– German, interestingly,31:40on a side note, they’re actually running it surpluses.31:43They’re getting criticized for that, which makes actually, I think Germany really an31:47interesting place to– if we do have a global recession, what country is actually able to31:54really deal and stimulate ultimately.31:58They’ve been very disciplined and holding off on this point, but I suspect they may32:02have more ammunition than anyone else when we do hit a recession down the road.32:09How do you see the end of the cycle playing out?32:11I am actually looking for a yearend rally, because I think what happened in December32:17of 2018 was superbly rare.32:20It happened only once before and that was in December of 2000.32:25That’s how rare these December dumps are.32:27However, I’m just going by what I know now, and I don’t know what’s going to happen with32:31the trade deal and this time, the other.32:32What I do know now is basically what I see in the charts is there’s just another very,32:38very sizable volatility spike to come.32:42I can’t tell you when that comes, it would maybe make sense for that to happen in October32:48or into November.32:50Then that spike is probably be a buy in markets for a yearend rally, can see that happening.32:57I expect the Fed to cut rates again in October, maybe throw another one in December.33:02We’ll see.33:03I think ultimately, the question is, and I’ve been posting this chart for months now.33:07It’s this broad megaphone pattern.33:09If they can get above it, we can have a massive all liquidity and ala March 2000.33:18It was just crazy blow off the top.33:21I’m not predicting this.33:23I’d actually don’t want to see that.33:24I think stuff like that is just going to be horrid ultimately, because it will just exacerbate33:29the pain on the downside.33:31If markets cannot sustain new highs from here, I think going actually back to an earlier33:37question you asked about historical example, look closely at 2007.33:42We made a high in July, we made a high in July this year, then the Fed cut rates in33:47September of 2007.33:49Because that was their response when subprime was contained.33:53Don’t worry about– there is no recession.33:55That’s the same narrative we’re hearing now, there’s not going to be a recession.34:00The recession came only two months after– three months after the Fed cut rates.34:04It came in December of 2007, when no one saw or admitted a recession was coming.34:11After that rate cut in 2007 in September, markets peaked in October, and that was it.34:16No one– this is the fascinating thing, see, market tops are only known in hindsight with34:23enough distance.34:24They’re not apparent or anyone at the time.34:28That’s why I’m just using that as an interesting example and as a threshold to say we must34:33make new highs from here or we’re risking, we’re actually made a double top in July and34:39in September of this year, so I think people need to watch the price action very carefully34:44from here.34:46Just finishing up on 2007, when markets made on marginal new high in October of 2007, and34:52the Fed was cutting rates, Wall Street projected price targets of 1500 to 1600 to 1700 for35:012008.35:02All of them.35:03All of them were bullish in December, not knowing that the session officially actually35:09started in December of 2007.35:11The S&P close the year at 800, 880, something like that, cut in half, basically.35:20I think what we all need to be closely watching for is efficacy of what happens on the trade35:26front, efficacy on what happens with the central banks and the price action in the charts.35:32Do we see participation coming from the small caps, transports and the banking sector?35:40Yes or no?35:41Will we see sustainable new highs or not?35:43If we don’t see new highs, risk for double top, watch what the VIX is doing and then35:49it remains a range bound market for now with opportunities and both sides but I think there’s35:54some critical thresholds that have taken place.35:57Punch line, no bull market without central bank intervention.36:02It remains an artificial construct.36:05I am worried that all of us have a warped perception of value of what markets should36:13be doing because, let’s be very clear here, we would not be at new highs in or we would36:19not have hit these current levels of 3000 in the S&P were it not for complete central36:25bank capitulation, four rate cuts, jawboning trade optimism, all these valuations have36:35to be justified at the end of the day.36:38You cannot lose one of these equations and so markets remain artificially inflated.36:45The question is if, like in 2000, or in 2007, central banks efficacy loses out.36:52Remember, they had to cut rates by over 500 basis points to stop the bleeding back then,36:58and now, they barely have 200 basis points to work with.
Source: CNBC: Aug 7, 2018
- Two key drivers are helping the stock market to rally: increased index fund buying and corporate share buybacks, CNBC’s Jim Cramer argues.
- Those two trends are creating a “stock shortage of epic proportions,” the “Mad Money” host says.
“We didn’t even have index funds back then,” he said. “Now they’re the preferred way to invest for the majority of people who want to own stocks.”
The flight to index funds stems from more savings-conscious consumers who, even though they are likelier to find jobs and make more money, are now focusing on keeping their earnings close rather than spending freely, Cramer said.
“On average, … people are saving a larger percentage of their paychecks. So where do they put their money? A lot of it goes into index funds,” he explained, adding that companies introducing no-fee index fund investing is “a catalyst for even more money coming into the indices.”
At the same time, corporate share buybacks are quickly becoming another source of fuel for stocks, the “Mad Money” host said.
He pointed to a Goldman Sachs analysis in which researchers said U.S. companies could buy back over $1 trillion worth of their shares in 2018. As a result, stocks would likely hold steady despite individual investors’ concerns about various economic pressures including global trade tensions.
Noting that corporate buyback announcements are up 46 percent versus last year, Goldman said that August is historically the most popular month for share repurchases, Cramer recounted.
And even though companies are not technically allowed to push their stocks higher via buybacks, Cramer said that “as someone who’s personally authorized and executed buybacks myself, I can tell you that they have the potential to give stocks a serious boost.”
So, with frugal investors buying up index funds, thus sending stocks higher, and companies gearing up for more stock buybacks, the effect on the market is tangible, the “Mad Money” host said.
“The impact of these two trends? Simple: they’ve created a stock shortage … of epic proportions,” he said. “There just aren’t enough shares of big-cap companies to go around until sellers materialize.”
To make matters worse for the bears, the bank stocks, a key market leadership group in Cramer’s eyes, are heading higher thanks to rising interest rates. And the price of oil — a flawed, but popular barometer for economic strength — is on the rise, signaling to money managers that there are “clear economic skies ahead,” Cramer said.
“If you only take one thing away from this segment, maybe for the whole night, understand that we’ve got a serious stock shortage on our hands at these levels,” the “Mad Money” host concluded.
“There just aren’t enough shares to go around, at least at the prices that we are trading at now, and it’s making even bearish money managers afraid to sell,” he continued. “At the end of the day, the stock market is a market like any other, which means it’s controlled by supply and demand. When there’s not enough supply, prices go higher. End of story.”
In this week’s Big Read at the Financial Times, well-known columnist Martin Wolf provides a shotgun-style summary of common objections to 21st-century capitalism. His 2,000-word condemnation of what he calls “Rentier Capitalism” includes almost every popular denouncement of capitalism of recent years and points to all the ways in which the modern world has supposedly let us down.
Most of them are tired clichés and hyperbolic tirades of doubtful accuracy: the unprecedented danger posed to civilized society that is tax havens; the mirage of ever-increasing market concentrations; and of course the perils of wage inequality, without which no condemnation of the era following the great financial crisis would be complete. Not only are financial services in general a parasitic drag on the economy (he literally uses the words “useless” and “unproductive” to describe the financial sector), but their appeal to talented people amounts to an unforgivable brain drain that explains the below-average productivity growth observed in modern Western economies.
Wolf, pouring old wine in new bottles, makes objections as old as economics itself. Even classical economists used to refer to rent extraction — an unfair gain of material resources from the fruits of capitalist development over what would have been required to induce individuals to bring them forth — as “unearned income” with the accompanying moralistic language.
While Wolf mentions some of the well-studied and conventional reasons why the 21st century has seen some of the trends he laments (globalization and superstar effects, the race between technology and education; network effects) he does not advance any reason to doubt those essentially descriptive explanations.
Instead, Wolf resorts to grand, utopian, and moralistic language. He would have us replace “a capitalism rigged to favour a small elite” with one “that gives everybody a justified belief that they can share in the benefits.” Remaining mysteries are who those people doing the rigging really are and why we can’t find the smoking gun of actually “rigging” the economy. In vain I have searched for both.
Especially prominent in Wolf’s text is the differences in earnings between workers and senior management. A particular evil, argues Wolf, is the practice of tying CEO remuneration to share prices, long seen as a successful solution to the principal–agent problem between shareholders and managers. In direct opposition to this Nobel Prize–winning insight, Wolf joins a jolly crowd of dissenters that, among others, includes Matt Yglesias, Paul Krugman, Bernie Sanders, Joe Biden, the occasional Economist editorial, and my modestly conspiratorial economics lecturer at University of Glasgow.
Even some market-friendly analysts have argued this point: share-price remuneration creates perverse incentives for managers who’d rather focus on increasing their company’s share price than making truly productive and beneficial investments for their companies. Runaway stock markets are not, mind you, outcomes of money printing, endless rounds of quantitative easing, or any other postcrisis central bank behavior, but due to senior management’s rent-seeking practice of taking up cheap debt to buy back shares in their own company. Let’s explore that a bit more.
What all economists must do is work through not only the primary effects of some event, but secondary and often third-order outcomes as well.
As an example, take “job creation” programs, lauded by almost all politicians. By only looking at the number of new jobs in such programs without considering the jobs destroyed by their funding or implementation, you are vastly overstating their real effect. As Bastiat taught us in his famous broken window fallacy, we must ask: what is given up elsewhere so that a desired policy can be realized?
By objecting to share buybacks, Wolf makes such a fallacious argument. His mistake lies in not looking beneath the surface.
What Happens When Companies Buy Back Their Own Shares?
Economics teaches us to think through problems wholly. Rather than accepting naive explanations that quickly come to mind or seem obvious on the surface, economic analysis delves deeper. In opaque and complicated financial systems like ours, a seemingly simple transaction can include countless more, blurring the assessments of what is going on.
With profits (or indeed newly issued debt), companies may buy and retire their own outstanding stock, authorized and managed by senior management whose salaries and bonuses are strictly tied to the company’s stock price. This, of course, looms large in the eyes of left-leaning critics. Share buybacks benefit “shareholders and corporate leadership” rather than their workers, argue Bernie Sanders and Chuck Schumer. Similarly, both Yglesias and Wolf seem to think that management is passing over productive investments and that buybacks add no value, effectively short-changing not only workers but ultimately owners as well, enriching only management.
What share buybacks do is intentionally reduce the outstanding capital of one’s own company. The managers are putting cash behind their conviction that owners can make better use of spare funds than the company can. As Erica York persuasively explains, companies buy back shares when they have “more cash than investment opportunities.”
It may be that the company has enough cash to sustain its current and future operations and is therefore in no need of the extra money. Another possibility is that a company — as most on the left call for governments to do — is taking advantage of low and even negative interest rates, in effect locking in cheap funding for the foreseeable future. When equity is expensive and debt is cheap and plentiful, prudent management should swap one for the other since dividend payments for shareholders come out of corporations’ positive free cash flows anyway. Even if there is something wrong with our extraordinarily low interest rates, it makes perfect sense for long-term business to take advantage of what looks like temporarily cheap funding.
Notice how Wolf’s sleight of hand undermines his argument. He says that share buybacks do not add value to “the company” with the implication that they don’t add value to the economy. The seller — the counterparty to the actual buyback transaction by the company — can either use the proceeds to buy another financial investment or consume them in the real economy. Below we’ll see how that benefits the economy.
Adding Value to the Economy
Monetary economics makes perfectly clear that money spent always goes somewhere. In this case, corporations buying back their own shares transfer funds to sellers of those shares — the funds do not “vaporize.” Wolf and others stop their assessment here and conclude that managers are transferring funds to shareholders in addition to enriching remaining shareholders when the stock price increases.
There are two reasons why the share price ought to rise: First, upon canceling some of the outstanding shares, every remaining share now represents a larger piece of the overall company. As this transaction didn’t change anything about the company’s underlying operations, every share should now be slightly more valuable. Second, if management successfully replaced expensive equity with cheap debt, the company’s effective cost of capital has fallen — making the shares more profitable investments, all things equal (in jargon, while net income falls due to higher interest rate expenses, the return on equity increases as the fewer shares outstanding more than offset the reduction in net income). This is value creation for the company’s shareholders as well as releasing funds for financial markets to profitably invest elsewhere.
Wolf’s failure to look past these initial effects detracts from his argument. A seller of stock now has funds at his disposal for which he has four actions available to him:
- Remain liquid, and so effectively provide reserves to his bank or broker that are used for loans elsewhere or pile up as excess reserves at the Fed.
- Buy another security on the secondary market.
- Invest the funds in an initial public offering (IPO), transferring his funds to a new and thriving business in need of funds.
- Remove the funds from the financial system and consume them.
If the seller remains liquid (1) or buys another security (2), he merely pushes the decision to another person faced with the exact same options. If he invests the funds in an IPO (3), the new company invests the proceeds in its operations. If he spends the proceeds in the real economy (4), they show up as somebody else’s income, add to GDP, and send market signals to entrepreneurs elsewhere in the economy to pivot some investment into these lines of production. However long this round of hot potato is, at the end there is a real transaction.
The financial system is beautiful in that a dozen or more internal transactions, through various routes, ultimately have the same outcome: funds are moved from places where they may not earn very much to where they might. In the share-buyback example that Wolf and others lament, idle cash is moved from a corporation that sees no need for it (or a bank reserve earning interest of excess reserves at the Fed) to fueling startups that do. Share buybacks do not, as Wolf seems to believe, occur “at the expense of corporate investment and so of long-run productivity growth” — that investment just takes place elsewhere.
The hypothetical company’s share buyback merely pushed the decision of what to do with the money to the next person in line — transferred the purchasing power from the company itself to somebody seeing more investment opportunities elsewhere.
It is perfectly possible that nobody in the economy sees any productive investments to make and so share buybacks would ultimately just end up in consumption. That might be a worrying sign and a real instance of secular stagnation. That’s not the argument Wolf makes.
Even if it were, his calls for reinvesting in the company or its workers are misguided. Spending money on new investments that the managers themselves don’t think will pay off seems like a surefire way to perpetuate such dismal productivity growth. If nobody in the entire economy can find profitable investments to make, companies naturally ought to liquidate their holdings and give assets back to their owners for consumption — which is precisely what share buybacks accomplish!
The confused objections to share buybacks illustrate the failure to look past the immediate effect and to understand what financial markets do. In a decentralized way, reacting and incorporating the best available information, they transfer funds from those with money but no ideas to those with ideas but lacking money. Financial markets efficiently allocate capital across the economy, but do so in roundabout ways that are easy to miss.
Looking past the immediate effect allows us to see the bigger picture: share buybacks are one cog in a well-functioning financial system, doing precisely what they are supposed to do. That’s a good thing — not something to lament.