Capital structure substitution theory

The CSS theory hypothesizes that managements of public companies manipulate capital structure such that earnings per share (EPS) are maximized. Managements have an incentive to do so because shareholders and analysts value EPS growth.

.. The capital structure substitution theory has the potential to close these gaps. It predicts a negative relation between leverage and valuation (=reverse of earnings yield) which in turn can be linked to profitability. But it also predicts that high valued small growth firms will avoid the use of debt as especially for these companies the cost of borrowing ({\displaystyle R_{\text{x,t}}}) is higher than for large companies, which in turn has a negative effect on their EPS. This is consistent with the finding that “…firms with higher current stock prices (relative to their past stock prices, book values or earnings) are more likely to issue equity rather than debt and repurchase debt rather than equity”.[4]

.. In times when the market is under-priced, corporate buyback programs will allow companies to drive up earnings-per-share, and generate extra demand in the stock market. In times when the index was under-priced relative to the model equilibrium, repurchase programs will be stopped and demand is reduced.

Why Capital Structure Matters

Companies that repurchased stock two years ago are in a world of hurt.

Thirty-five years ago business publications were writing that major money-center banks would fail, and quoted investors who said, “I’ll never own a stock again!” Meanwhile, some state and local governments as well as utilities seemed on the brink of collapse. Corporate debt often sold for pennies on the dollar while profitable, growing companies were starved for capital.


If that all sounds familiar today, it’s worth remembering that 1974 was also a turning point. With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing. Bonds rallied strongly in 1975-76, providing underpinning for the stock market, which rose 75%. Some high-yield funds achieved unleveraged, two-year rates of return approaching 100%.

The accessibility of capital markets has grown continuously since 1974. Businesses are not as dependent on banks, which now own less than a third of the loans they originate. In the first quarter of 2009, many corporations took advantage of low absolute levels of interest rates to raise $840 billion in the global bond market. That’s 100% more than in the first quarter of 2008, and is a typical increase at this stage of a market cycle. Just as in the 1974 recession, investment-grade companies have started to reliquify. Once that happens, the market begins to open for lower-rated bonds. Thus BB- and B-rated corporations are now raising capital through new issues of equity, debt and convertibles.

This cyclical process today appears to be where it was in early 1975, when balance sheets began to improve and corporations with strong capital structures started acquiring others. In a single recent week, Roche raised more than $40 billion in the public markets to help finance its merger with Genentech. Other companies such as Altria, HCA, Staples and Dole Foods, have used bond proceeds to pay off short-term bank debt, strengthening their balance sheets and helping restore bank liquidity. These new corporate bond issues have provided investors with positive returns this year even as other asset groups declined.

The late Nobel laureate Merton Miller and I, although good friends, long debated whether this kind of capital-structure management is an essential job of corporate leaders. Miller believed that capital structure was not important in valuing a company’s securities or the risk of investing in them.

My belief — first stated 40 years ago in a graduate thesis and later confirmed by experience — is that capital structure significantly affects both value and risk. The optimal capital structure evolves constantly, and successful corporate leaders must constantly consider six factors

  1. the company and its management,
  2. industry dynamics, t
  3. he state of capital markets,
  4. the economy,
  5. government regulation and social trends.

When these six factors indicate rising business risk, even a dollar of debt may be too much for some companies.

Over the past four decades, many companies have struggled with the wrong capital structures. During cycles of credit expansion, companies have often failed to build enough liquidity to survive the inevitable contractions. Especially vulnerable are enterprises with unpredictable revenue streams that end up with too much debt during business slowdowns. It happened 40 years ago, it happened 20 years ago, and it’s happening again.

Overleveraging in many industries — especially airlines, aerospace and technologystarted in the late 1960s. As the perceived risk of investing in such businesses grew in the 1970s, the price at which their debt securities traded fell sharply. But by using the capital markets to deleverage — by paying off these securities at lower, discounted prices through tax-free exchanges of equity for debt, debt for debt, assets for debt and cash for debt — most companies avoided default and saved jobs. (Congress later imposed a tax on the difference between the tax basis of the debt and the discounted price at which it was retired.)

Issuing new equity can of course depress a stock’s value in two ways:

  1. It increases the supply, thus lowering the price; and it
  2. “signals” that management thinks the stock price is high relative to its true value.

Conversely, a company that repurchases some of its own stock signals an undervalued stock. Buying stock back, the theory goes, will reduce the supply and increase the price. Dozens of finance students have earned Ph.D.s by describing such signaling dynamics. But history has shown that both theories about lowering and raising stock prices are wrong with regard to deleveraging by companies that are seen as credit risks.

Two recent examples are Alcoa and Johnson Controls each of which saw its stock price increase sharply after a new equity issue last month. This has happened repeatedly over the past 40 years. When a company uses the proceeds from issuance of stock or an equity-linked security to deleverage by paying off debt, the perception of credit risk declines, and the stock price generally rises.

The decision to increase or decrease leverage depends on market conditions and investors’ receptivity to debt. The period from the late-1970s to the mid-1980s generally favored debt financing. Then, in the late ’80s, equity market values rose above the replacement costs of such balance-sheet assets as plants and equipment for the first time in 15 years. It was a signal to deleverage.

In this decade, many companies, financial institutions and governments again started to overleverage, a concern we noted in several Milken Institute forums. Along with others, including the U.S. Chamber of Commerce, we also pointed out that when companies reduce fixed obligations through asset exchanges, any tax on the discount ultimately costs jobs. Congress responded in the recent stimulus bill by deferring the tax for five years and spreading the liability over an additional five years. As a result, companies have already moved to repurchase or exchange more than $100 billion in debt to strengthen their balance sheets. That has helped save jobs.

The new law is also helpful for companies that made the mistake of buying back their stock with new debt or cash in the years before the market’s recent fall. These purchases peaked at more than $700 billion in 2007 near the market top — and in many cases, the value of the repurchased stock has dropped by more than half and has led to ratings downgrades. Particularly hard hit were some of the world’s largest companies (i.e., General Electric, AIG, Merrill Lynch); financial institutions (Hartford Financial, Lincoln National, Washington Mutual); retailers (Macy’s, Home Depot); media companies (CBS, Gannett); and industrial manufacturers (Eastman Kodak, Motorola, Xerox).

Without stock buybacks, many such companies would have little debt and would have greater flexibility during this period of increased credit constraints. In other words, their current financial problems are self-imposed. Instead of entering the recession with adequate liquidity and less debt with long maturities, they had the wrong capital structure for the time.

The current recession started in real estate, just as in 1974. Back then, many real-estate investment trusts lost as much as 90% of their value in less than a year because they were too highly leveraged and too dependent on commercial paper at a time when interest rates were doubling. This time around it was a combination of excessive leverage in real-estate-related financial instruments, a serious lowering of underwriting standards, and ratings that bore little relationship to reality. The experience of both periods highlights two fallacies that seem to recur in 20-year cycles: that any loan to real estate is a good loan, and that property values always rise. Fact: Over the past 120 years, home prices have declined about 40% of the time.

History isn’t a sine wave of endlessly repeated patterns. It’s more like a helix that brings similar events around in a different orbit. But what we see today does echo the 1970s, as companies use the capital markets to push out debt maturities and pay off loans. That gives them breathing room and provides hope that history will repeat itself in a strong economic recovery.

It doesn’t matter whether a company is big or small. Capital structure matters. It always has and always will.

The S.E.C. Rule That Destroyed The Universe

How the coronavirus is creating a political opportunity to overturn one of the worst practices of the kleptocracy era

The Covid-19 crisis has revealed gruesome core dysfunction.

  • Drug companies have to be bribed to make needed medicines,
  • state governments improvise harebrained plans for emergency elections, and
  • industrial capacity has been offshored to the point where making enough masks seems beyond the greatest country in the world.

But the biggest shock involves the economy. How were we this vulnerable to disruption? Why do industries like airlines that just minutes ago were bragging about limitless profitability – American CEO Doug Parker a few years back insisted, “My personal view is that you won’t see losses in the industry at all” – suddenly need billions? Where the hell did the money go?

In Washington, everyone from Donald Trump to Joe Biden to Alexandria Ocasio-Cortez is suddenly pointing the finger at stock buybacks, a term many Americans are hearing for the first time.

This breaks a taboo of nearly forty years, during which politicians in both parties mostly kept silent about a form of legalized embezzlement and stock manipulation, greased by an obscure 1982 rule implemented by Ronald Reagan’s S.E.C., that devoured trillions of national wealth.

The mechanics of buybacks are simple. Companies buy their own stock and retire the shares, increasing the value of shares remaining in circulation. This translates into instant windfalls for shareholders and executives that approve the purchases. That this should be proscribed as market manipulation, and additionally offers a clear path to insider trading – former SEC chief Rob Jackson found corporate insiders were five times as likely to sell stock after a share repurchase was announced – is just one problem.

The worse problem comes when companies not only spend all of their available resources on stock distributions, but borrow to fund even more distributions. This leaves companies with razor-thin margins of error, quickly exposed in a crisis like the current one.

“When companies spend billions on buybacks, they’re not spending it on research and development, on plant expansion, on employee benefits,” says Dennis Kelleher of Better Markets. “Corporations are loaded up with debt they wouldn’t otherwise have. They’re intentionally deciding to live on the very edge of calamity to benefit the richest Americans.”

It’s hard to overstate how much money has vanished. S&P 500 companies overall spent the size of the recent bailout – $2 trillion – on buybacks just in the last three years!

Banks spent $155 billion on buybacks and dividends across a 12-month period in 2019-2020. As former FDIC chief Sheila Bair pointed out last month, “as a rule of thumb $1 of capital supports $16 of lending.” So, $155 billion in buybacks and dividends translates into roughly $2.4 trillion in lending that didn’t happen.

Most all of the sectors receiving aid through the new CARES Act programs moved huge amounts to shareholders in recent years. The big four airlines – Delta, United, American, and Southwest – spent $43.7 billion on buybacks just since 2012. If that sum sounds familiar, it’s because it equals almost exactly the size of the $50 billion bailout airlines are being given as part of the CARES Act relief package.

The two major federal financial rescues, in 2008-2009 and now, have become an important part of a cover story shifting attention from all this looting: the public has been trained to think companies have been crippled by investment losses, when the biggest drain has really come via a relentless program of intentional extractions.

Corporate officers treat their own companies like mob-owned restaurants or strip mines, to be systematically pillaged for value using buybacks as the main extraction tool. During this period corporations laid off masses of workers they could afford to keep, begged for bailouts and federal subsidies they didn’t need, and issued mountains of unnecessary debt, essentially to pay for accelerated shareholder distributions. 

All this was done in service of a lunatic religion of “maximizing shareholder value.” “MSV” by now has been proven a moronic canard – even onetime shareholder icon Jack Welch said ten years ago it wasthe dumbest idea in the world – and it’s had the result of promoting a generation of corporate leaders who are

  • skilled at firing people,
  • hustling public subsidies, and
  • borrowing money to fund stock awards for themselves, but
  • apparently know jack about anything else.

During a Covid-19 crisis where we need corporations to innovate and deliver life-saving goods and services, this is suddenly a major problem. “We’re seeing, these people don’t have the slightest idea of how to run their own companies,” says Harvard economist William Lazonick.

Wall Street analysts spent the last weeks mulling over the grim news that society is wondering if it can afford to keep sending most of its wealth to a handful of tax-avoidant executives and corporate raiders (known euphemistically in the 21stcentury as activist investors). The Sanford Bernstein research firm sent a note to clients Monday warning buybacks would be “severely curtailed” in coming years, for the “intriguing” reason that they were becoming “socially unacceptable” in this crisis period. 

Goldman, Sachs chimed in with a similar observation. “Buyback activity will slow dramatically, both for political and practical reasons,” the bank told clients.

The political furor on the Hill in the last weeks has mostly been limited to grandstanding demands that recipients of aid in the $2 trillion CARES Act not be spent on stock distributions. “I’ll take it, but most of them don’t know what the hell they’re talking about,” is how one economist described these complains.

If politicians did understand the buyback issue more fully, they either wouldn’t have voted for this unanimously-approved bailout, or would have insisted on permanent bans, given the central role such extraction schemes played in necessitating the current crisis to begin with. The history is ridiculous enough.


The newspaper record of November 17, 1982 shows an ordinary day from the go-go Reagan years. Republicans boosted tax cuts and military budget hikes. An NFL player strike ended after 57 days. Soviet and Chinese foreign ministers met, and 80 complete skeletons were found in a dig at Mount Vesuvius in what one scientist called a “masterpiece of pathos.”

There was little news of a rule passed by the Securities and Exchange Commission and implemented with almost no documentary footprint. “It’s not written about in histories of the S.E.C.,” says Lazonick. “It’s barely mentioned even in retrospect.”

Yet rule 10b-18, which created a “safe harbor” for stock repurchases, had a radical impact. For decades before Reagan came into office and stuck E.F. Hutton executive John Shad in charge of the S.E.C. – the first time since inaugural chief Joseph Kennedy’s tenure in the thirties that a Wall Street creature had been made America’s top financial regulator – officials had tried numerous times to define insider purchases of stock as illegal market manipulation.

Again, when companies buy up their own stock, they’re artificially boosting the value of the remaining shares. The rule passed by Shad’s S.E.C. in 1982 not only didn’t define this as illegal, it laid out a series of easily-met conditions under which companies that engaged in such buybacks were free of liability. Specifically, if buybacks constituted less than 25% of average daily trading volume, they fell within the “safe harbor.”

The S.E.C. in adopting the rule emphasized the need for the government to get out of the way of such a good thing:

The Commission has recognized that issuer repurchase programs are seldom undertaken with improper intent… any rule in this area must not be overly intrusive.

The rule added that companies may be justified in “stepping out” of safe harbor guidelines, and said that there would be no presumption of misconduct if purchases were not made in compliance with 10b-18. Thirty-three years later, in 2015, S.E.C. Chief Mary Jo White would double down on this extraordinary take on “regulation,” saying that “because Rule 10b-18 is a voluntary safe harbor, issuers cannot violate the rule.”

10b-18 was a victory for a movement popularized in the late sixties by Milton Friedman and furthered in the mid-seventies by academics like Michael Jensen and Dean William Meckling. The aim was to change the core function of the American corporation. If corporate officers previously had to build value for a variety of stakeholders – customers, employees, the firm itself, society – the new idea was to narrow focus to a single variable, i.e. “maximizing shareholder value.”

Like objectivism and other greed-based religions that helped birth the modern version of corporate capitalism, “MSV” was anchored on hyper-rosy assumptions tying efficiency to self-interest. It was said CEOs paid in stock would become owners, which would lead to reductions in spending on private jets and other waste.

Shareholders previously were paid via dividends, or by waiting for share prices to appreciate and selling them. Now there was a shortcut: board members chosen by shareholders could raid their own companies’ assets to buy stock and to goose share prices. 

Employees, customers, and society were suddenly in direct competition for resources with executives and shareholders. Should a company invest in a new factory, or should it just deliver instant millions to shareholders and executives paid in options?

By 1997, MSV became orthodoxy, as the Business Roundtable declared that the “paramount duty of management and of boards of directors is to the corporation’s stockholders.” This was understood to mean that the sole purpose of the corporation was to create value for shareholders.

In the 2008 financial crisis, many firms poured resources into buybacks even as they hurtled toward bankruptcy. Some kept shifting money to stock buys practically until the day of their deaths. Lehman Brothers, for instance, announced a 13% dividend increase and a $100 million share repurchase in January 2008, when the firm was already circling the drain. Many of the TARP bailout recipients kept up buybacks even during the bleakest days of the financial crisis.

“If you added up the capital distributions of the banks in just the few years before the crash,” says Kelleher, “it adds up to half the TARP. They wouldn’t have needed a bailout if they’d [curbed] distributions.”

Before and after 2008, American companies repeatedly begged to be subsidized by taxpayers even as they systematically liquidated revenues via buybacks.

For instance, as Lazonick pointed out in a 2012 paper, Intel in 2005 lobbied the U.S. government to invest in nanotechnology, warning “U.S. leadership in the nanoelectronics era is not guaranteed” and would be lost absent a “massive, coordinated research effort” that included state and federal investment. That year, Intel spent $10.5 billion on buybacks, and spent $48.3 billion on them in 2001-2010 overall, four times what the federal government ended up spending on the National Nanotechnology Initiative

The classic extraction trifecta was to ask for public investment, take on huge debts, and enact mass layoffs as a firm spent billions on distributions.

Microsoft in 2009 laid off 5,000 workers (its first mass layoff) and did a $3.75 billion bond issue (its first long-term bond) despite earning $19 billion. That same year, the company spent $9.4 billion on buybacks and $4.5 billion on dividends. Lazonick argues such cash-rich companies borrowed money in order to avoid having to repatriate overseas profits, which would have forced them to pay taxes before blowing cash on buybacks.

Buyback waste is breathtaking. Exxon-Mobil, apparently disinterested in researching alternative energy sources, did $174 billion in buybacks between 2001-2010. The nation’s 18 largest pharmaceutical companies, who feed off NIH grants for free research and have relentlessly lobbied to be protected from generics, reimportation, the use of Medicare’s bargaining power to lower prices, spent $388 billion on buybacks in the last decade.

Apple, upon whose board sits relentless seeker-of-green-technology-seed-capital Al Gore, did $45 billion in buybacks in one year (2014) and $239 billion over a six year period between 2012 and 2018. Gore also owned over 79,000 shares of Apple as of last January, and sold nearly $40 million worth of Apple stock in February of 2017. So he’s probably not too upset that Apple is spending sums equivalent to major bailout programs on stock repurchases, rather than investing in new technologies.

In March of 2018, Wisconsin Senator Tammy Baldwin finally introduced legislation to halt the practice, called the Reward Work Act, which would:

Ban open-market stock buybacks that overwhelmingly benefit executives and activist hedge funds at the expense of workers and retirement savers. It would also empower workers by requiring public companies to allow workers to directly elect one-third of their company’s board of directors.

In summer of 2019, the Business Roundtable shook corporate America by abandoning “shareholder value” as the animating principle of American business. This led to a spate of breathless news reports: “Shareholder Value Is No Longer Everything” (New York Times), “Group of US corporate leaders ditches shareholder-first mantra” (Financial Times) and, “Maximizing Shareholder Value is Finally Dying” (Forbes).

This was all going on against the backdrop of a Democratic presidential election campaign that in the campaigns of Bernie Sanders and Elizabeth Warren especially saw the rise of furious anti-corporate sentiment. The Roundtable response might have been P.R. designed to dull the pitchforks somewhat, but it’s notable that there was enough worry about the optics of shareholder piggery to even do that much.

As Forbes put it:

Maximizing shareholder value has come to be seen as leading to a toxic mix of soaring short-term corporate profits, astronomic executive pay, along with stagnant median incomes, growing inequality, periodic massive financial crashes, declining corporate life expectancy, slowing productivity, declining rates of return on assets and overall, a widening distrust in business…

Economist Lenore Palladino, who has worked on these issues for years, hopes Covid-19 and other looming crises will force politicians and the public to see fundamental changes to corporate structure as inevitable.

“I believe there will be a political mandate to ensure business resiliency in the 2020s, not only to survive coronavirus, but so that the American workforce can thrive in the era of climate change,” she says. Banning buybacks, she says, would (among other reforms) comprise “one step towards rebalancing power inside corporations.”

However, unless the public puts more pressure on politicians to keep the issue alive during the coronavirus crisis, the $2 trillion rescue and the near-daily barrage of radical new bailout facilities being introduced – the Fed as of this writing is introducing yet another amazing “bazooka” program to hoover up junk bonds – could just end up subsidizing the last decade of buybacks.

If political focus on repurchases becomes a purely temporary policy fixation, a la Joe Biden’s “CEOS should wait a year before gouging their own firms again” proposal, this bailout will be massively counterproductive, enshrining buybacks in non-emergency times as a legitimate practice. If we can’t fix a glitch as obvious as 10b-18, what can we change?

The Story of the Seven Dwarfs Mining Inc: | How the Coronavirus Masked the Corporate Debt Bubble

Disney’s Seven Dwarfs team up to tell the story of corporate America (2012-2020)

by Tim Langeman 2233 words (17 min read)


Before the coronavirus, a false narrative arose that the economy was healthy, as measured by:

  • growth in the stock market and a
  • reduction in the unemployment rate 

when in fact the recovery from the 2008 financial crisis was weak and the facade of strength was masked by low-interest rates which enabled governments, corporations, and individuals to achieve the illusion of prosperity through increased borrowing.1

Wall Street Bubbles Cartoon, 1901
1901 Cartoon depicting JP Morgan as Bull

But there is more to the economy than the stock market and unemployment rate. The bond market is larger and “smarter” than the stock market. When assessing the pre-coronavirus economy, one must also take into account the stagnant profits2 corporations disguised by borrowing in the bond market to fund purchases of their own stock, artificially inflating the stock market.

Like an Injured Athlete taking Pain Killers

The US economy was like a professional football player who had been “playing hurt” for many years.

Brandon Scherff Injury: Falcons at Redskins 11/04/18
Brandon Scherff Injury, Nov 4, 2018
Keith Allison Sports Photos (CC BY-SA 2.0)

The economy used debt like the football player uses pain killers.  The debt masked the economy’s problems3 and allow it to perform at a higher level than otherwise would have been possible had pain-killers not dampened the brain’s ability to perceive reality.  But unfortunately, an economy is not like an athlete in that it can’t retire at the end of a 15-year career.

Featuring: The Seven Dwarfs

The story I’m about to tell is intended to illustrate how corporations borrowed money and then used that money to buy their own stock, inflating the stock price.4  In finance jargon, this is called “leveraged stock buybacks”.5  Corporations have used stock buybacks as a major strategy to boost their share price but many corporations didn’t have enough profits to buy back their stock because the overall level of (pre-tax) corporate profits has been flat since 2012.6.  While some companies may have been able to legitimately afford to buy their own stock with real profits, over 50% of those buybacks were done using borrowed money.

In fact, if you look at who had been the buyer of most of the stock purchases in 2018 and 2019, it had mostly been the companies themselves purchasing their own stock, not pension funds, individuals, or hedge funds.

I illustrate how this market manipulation works using a fairy tale featuring the seven dwarfs and their mining company “7 Dwarfs Mining, Inc.” Early in the story, the dwarfs seemed to have discovered an easy way of making money until an unforeseen emergency struck and disrupted their carefully laid plans.

It is commonly known that emergencies reveal.

This story illustrates what emergencies can conceal.

The Founding Members:

Grumpy Dwarf
Grumpy Dwarf

Once upon a time, the 7 Dwarfs Mining company was founded in a small Forest Kingdom town by Seven dwarfs:7

  1. Dopey,
  2. Doc,
  3. Bashful,
  4. Happy,
  5. Grumpy,
  6. Sleepy, and
  7. Sneezy

After a number of years in business together, the mining company was valued at $7 million8 and generated $700,000 in profit per year, which they split 7 ways.9

Assets # of Shares Yearly Profit Profit per Share Debt
$7 million 7 $700,000 $100,000 $0

Going Into Debt to Hide Flat Growth

Federal Reserve: Profits before Taxes
Notice how Corporate Profits flattened out over the last 6-8 years

One year, Grumpy decided he was unhappy in the mining business. Perhaps this was due to his sour attitude, or perhaps he was feeling blue because the mine’s profits had not increased at all in the previous 6 years.10 Grumpy decided to sell his share in the mining company, but there were not a lot of other dwarfs that wanted to buy out his stake at the price of $1 million.

The other 6 dwarfs in the company wanted to continue in the business but they didn’t have the cash to buy out Grumpy, so they decided to borrow the $1 million from the bond market. Interest rates were low in the Forest Kingdom because the economy hadn’t fully recovered from the previous debt-fueled financial crisis a dozen years prior.11 The kingdom’s treasury secretary’s belief that low-interest rates stimulate growth was also a factor in setting the interest-rate climate.12 This easy lending environment allowed the dwarfs to succeed in borrowing $1 million at an interest rate of 3% per year.

The Dwarfs’ Epiphany: Earnings per Share

Earnings per Share
Earnings Per Share by Nick Youngson
CC BY-SA 3.0 Alpha Stock Images

After Grumpy exited the company, the 6 remaining dwarfs renamed their business: “6 Dwarfs Mining, Inc“. The total value of the company (market cap)13 was still $7 million and they split the same $700,000 profit six ways instead of seven. This resulted in profits of $116,666/share, a 16.7% increase over the prior year. Grumpy sulked for the next year and a half about missing out on the share price increase his exit had created, but Dopey reminded him that it was his own idea to leave. 🙁

Exit Market Cap Leverage Ratio Yearly Profit Profit per Share % Profit Increase
per Share
Equity Debt
Original 7 Dwarfs $7 m 7/7 $700,000 $100,000 $7 m $0
Post-Grumpy Exit $7 m 7/6 $700,000 $116,667 14 16.7% $6 m $1 m
(Note: I’m abbreviating “million” as “m” to save space in this chart.)

Upon learning of this increase in EPS (Earnings Per Share), the 6 remaining dwarfs were elated! By taking on debt to buy out Grumpy’s stake, they managed to reduce their number of shares, thereby achieving their first share price increase in 6 years! Things were looking up! **

** “Earnings per Share” were up even though the Dwarf’s equity in the company was down.15

Scrabble Series Debt
Scrabble Series Image By:

Setting Dopey’s Debt Plan in Motion

Bashful was known to wear his heart on his sleeve, especially if he had romantic feelings for someone.16 So the next year, after Bashful’s most recent crush departed the village, Dopey encouraged a lovestruck Bashful to retire from the company and follow his sweetheart to the neighboring Mountain Kingdom to the North. Dopey wanted to reduce that number of shareholders in the mining company because he had learned the benefits of having fewer shareholders from Grumpy’s exit, even if that comes at the expense of having more debt. He calculated that splitting $7 million five ways would result in a share price of $1.4 million per share. This would be a 40% increase over the original $1 million share price, although the company’s profit was still the same $700,000 per year. Once again, the dwarfs went to the bond market and used borrowed money — an additional $1 million dollars — to buy out one of their fellow dwarf’s share.

Exit Market Cap Leverage Ratio Yearly Profit Profit per Share % Profit Increase
per Share
Equity Debt
Original 7 Dwarfs $7 m 7/7 $700,000 $100,000 $7 m $0
Post-Grumpy Exit $7 m 7/6 $700,000 $116,667 16.7% $6 m $1 m
Post-Bashful Exit $7 m 7/5 $700,000 $140,000 17 40% $5 m $2 m

After the successful payoff, Dopey said to Doc: “Wow, this debt thing is really an easy win. A few years ago we were struggling with plans to make efficiency improvements to the mines but that would have required us to invest some of our profits into new machinery, research and development, and employee training. Instead, I only needed to identify the key to Bashful’s heart and use some accounting wizardry18 to increase our share price the “easy way” — with more debt.”

Following the Plan

Dopey had a reputation for harebrained plans, but he knew that Sleepy’s drowsiness was no reason to doubt his intelligence or acumen.19 Dopey concluded that the two things that would most motivate Sleepy to sell his share were the attraction of sleeping in until noon and a bonus of $100,000, so he struck up a conversation with Sleepy on these two themes when the two had a private moment together. The next year, Sleepy was enjoying a restful retirement in the tropics and the mining company had one fewer shareholder.

2020 Ferrari F8 Tributo
2020 Ferrari F8 Tributo
Debt King License Plate
Debt King License Plate

The pattern continued again the following year with Happy given a $150,000 bonus contingent on his retirement, causing the share price to rise to $2,333,333 (a 133% increase). All the remaining dwarfs were extremely happy at this turn of events, as was Happy himself. 🙂 Dopey took out a loan to buy a red Ferrari with the vanity license plate “Debt King” in anticipation of his upcoming buyout. Yet, at the same time, the company’s total profit remained the same $700,000 per year it had been originally before Grumpy exited.20

Exit Market Cap Leverage Ratio Yearly Profit Profit per Share % Profit Increase
per Share
Equity Debt
Original 7 Dwarfs $7 m 7/7 $700,000 $100,000 $7 $0 m
Post-Grump Exit $7 m 7/6 $700,000 $116,667 16.7% $6 m $1 m
Post-Bashful Exit $7 m 7/5 $700,000 $140,000 40% $5 m $2 m
Post-Sleepy Exit $7 m 7/4 $700,000 $175,000 75% $4 m $3 m
Post-Happy Exit $7 m 7/3 $700,000 $233,333 21 133% $3 m $4 m

(Note: These figures are simplified. They do not include reinvesting profits or interest charges on the debt.)


A Declining Credit Rating

Credit Rating Chart
Credit Rating Chart

One of the unnoticed consequences of Dopey’s plan was that the mining company’s credit rating began to deteriorate as the company borrowed money in the bond market. The company was effectively agreeing to devote some of its future revenue (i.e. paying interest on the additional debt in the future) in exchange for a higher earnings per share today. Before Grumpy exited, the company had a AAA credit rating, but as Bashful, Sleepy, and Happy’s shares were bought out, the company’s credit rating fell to AA, then A and now stood at BBB, the lowest investment grade.22

Dopey was warned that if the company was assessed another credit downgrade the company would fall to a non-investment grade status (often referred to as “junk” bond status23). Were that to happen, pension funds and many investors would no longer be legally permitted to own the company’s debt and the interest rate the dwarfs would have to pay would spike higher. Dopey calculated that there was a higher risk to the company’s finances in the coming years, but he figured that would be Doc and Sneezy’s problem, not his, because he, Dopey, planned to be the next dwarf to exit. After Dopey left the company his financial interests would be separate from the mining company and he would not longer care if the company should happen to suffer losses.

The Unforeseen

Rapidico virus

The number of shares now stood at 3, with Dopey, Doc, and Sneezy remaining, when something unforeseen happened — a sickness called Rapidico took hold in the neighboring kingdom of Achin. As the illness reached the cities of the Dwarfs’ Forest Kingdom the advisors to the kingdom’s Queen — Queen Elizabeth II’s24 privy council25recommended that the kingdom go into lockdown to prevent the spread of the disease.

The Response

A lockdown seemed like a radical idea and one that the queen deferred to individual provinces.26 As other provinces of the kingdom went into lockdown, Dopey, Sneezy, and Doc were dismissive and continued business as usual at 3 Dwarfs Mining, Inc.

Sneezy Dwarf
Sneezy (Disney Fandom)

A month and a half later, an outbreak of Rapidico took place at 3 Dwarfs Mining, Inc., set off by an asymptomatic Sneezy. Dopey later recalled, “Sneezy is always sneezing; I didn’t think nothing of it.” But the tight quarters of the mine proved to be fertile ground for the contagion to spread and many mine workers were infected. True to his name, Doc threw himself into the job of treating the afflicted dwarfs and heroically saved countless lives, but the mine’s production ground to a halt nonetheless. Other businesses were similarly affected and the queen was forced to move beyond her earlier deference to provincial autonomy and call for a strict quarantine.27

Quarantine Sign
Quarantine (

The Divided Kingdom

Because the Forest Kingdom was so fractious and the forest creatures so impatient, financially vulnerable, and headstrong, not all parts of the kingdom followed the queen’s orders closely. This disunity among the provinces resulted in stubborn pockets of disease in the lagging parts of the kingdom which hampered the economic recovery.28

The length of the quarantine caused heavy losses to the 3 Dwarfs Mining, Inc., requiring them to borrow more money. Of the original $7 million that the company had started with, the 3 Dwarfs Mining Inc had only $3,638,841 equity left ($9,846,549 assets – 6,207,708 debt)29 because they had borrowed in the bond market to buy out the shares of Grumpy, Bashful, Sleepy, and Happy, resulting in a debt of $6,207,708.30

The Risk and Reward of a High Leverage Ratio

Debt vs. Equity: The Risk and Reward of Leverage: Dopey's Debt Plan

Companies can choose how much risk they want to take to accelerate growth (Risk vs Reward). The use of debt is a key contributor to the speed at which a company can grow but it also increases the risk that the company will falter should an unforeseen risk arise.

In this particular case, the leverage ratio31 I’m comparing is the ratio of market cap32 to debt. Notice how the Leverage ratio increases as the number of shares (or equity) decrease. Reducing the equity, in this case, increases the leverage ratio (7/2 = 3.5), which increases the profit per share.

Notice how the profit per share increases as the leverage ratio increases.

Exit Market Cap Leverage Ratio Leverage Profit per Share
Original 7 Dwarfs $7 million 7/7 1.0 $100,000
Post-Grump Exit $7 million 7/6 1.17 $116,667
Post-Bashful Exit $7 million 7/5 1.4 $140,000
Post-Sleepy Exit $7 million 7/4 1.75 $175,000
Post-Happy Exit $7 million 7/3 2.33 $233,333
Planned Dopey Exit $7 million 7/2 3.533 $350,000

Note: This chart has been simplified34

When Dopey planned to exit, the share price would have risen from $1 million to $3.5 million on the leverage ratio alone. A more complex calculation that reinvests profits each year would have the original $1 million share price to rise to $4,923,274, not including a bonus of $200,000, which would leave Dopey with a total exit package of $5.1 million dollars!35

When things are going well, leverage has the effect of multiplying a company’s earnings per share by the leverage ratio. But when an unforeseen tragedy hits, it leaves companies with less of a cushion to ride out a storm.

The “Debt Bomb” Goes Undiscovered

Debt Bomb
Debt Bomb (Creative Commons Zero – CC0 )

There had been a concern before the Rapidico virus hit, that a large number of Forest Kingdom companies had also been following Dopey-like plans to increase their share price the easy way — through financialization — that is “financial engineering” that inflates share price but does nothing to improve labor productivity. In the 7 Dwarfs Mining Company, the profit doesn’t grow at all, but EPS (earnings per share) still goes up anyway because the number of shares goes down. The shareholders retain ownership in the company, but often with higher levels of debt.

Resetting the “Debt Bomb”

Ticking Time Bomb
Reset the Clock on a Debt Bomb Creative Commons 4.0 BY-NC

The result is a potential “debt bomb”36 37 where a buildup of debt can threaten the whole economy. The companies contributing to this “debt bomb” report share price growth, but this “growth” is artificial because total profits are flat and earnings per share growth are only made possible by taking on more debt. When the debt bomb explodes (or pops like a bubble) it threatens to spill over into the broader economy, threatening the whole country, not just the borrowers. 38

The Rapidico crisis had given the government the opportunity to blame some of the kingdom’s problems, which had been years in the making, on the Rapidico virus and the country of Achin, even though a significant part of the financial problems were the fault of the kingdom’s systemic dysfunction. Had the kingdom not already experienced a financial crisis a dozen years prior, and had there not been such low interest-rates, the Dwarfs would not have taken on so much debt, leaving their mining company financially vulnerable in a time of crisis. Had the Rapidico crisis not happened, such debt dysfunction was bound to lead to another recession anyway and leave the kingdom to grapple with questions about the authenticity of the prior decade’s growth.

Debt for Productive Purposes?

Amish Hay Wagons
Productive Purposes

When some of the queen’s more intellectually self-critical advisors speculated that it would have been better had the Forest Kingdom’s companies invested the money they borrowed into productive assets rather than share buybacks, others replied that too few workers could afford to buy39 what the companies would have produced.4041

Sweeping it Under the Rug?

Sweep it Under the Rug
Sweep it Under the Rug
from “Whistle While You Work”
Disney’s Snow White and the 7 Dwarfs, 1937

A lone advisor commented that the prior 6-8 years of flat profits42 during supposed “good times” boded poorly for future growth prospects. “When was the last time we’ve generated substantial growth without a lot of debt and the creation of another artificial bubble?”43, said the deputy finance minister. Many advisors agreed with her, but were hesitant to break the bad news to the public. Nevertheless, all agreed that the queen’s legacy depended upon her taking steps to prevent such a debt bomb from re-emerging and requiring yet another bailout. You might be able to afford this bailout, but we haven’t done anything to pay down the debt from the previous financial crisis and we certainly can’t afford to make bailouts the norm. Next time, her advisors said, you won’t have the Rapidico virus to blame for the bailout and you won’t be able to sweep all that debt under the rug.

Will the Dopey Financial Plans Stay Concealed?

A cute little girl is hiding behind a tree and peeks around holding her finger to her lips saying, shhh
Stay Hidden? photo by Sheila Brown (CC0 Public Domain)

“I know great nations face their problems, rather than distract the public with diversions,” said the queen,44 but a financial crisis is no time to address deep weaknesses within the economy. Calling attention to the country’s debt dysfunction will only erode consumer confidence when we need it most. Besides, many of the Debt-Dopies are particularly crafty and hire former members of parliament as their lobbyists! Another bailout is inevitable. It is better for me to let the “Debt Dopies” 45 remain concealed by the wider bailout, for now, encourage optimism about the economy’s revival, and let someone else deal with the problem later.”

To repeat my opening statement:

It is commonly known that emergencies reveal.

This story illustrates what emergencies can conceal.

Dopey Dwarft
Dopey’s Debt Plan to increase EPS (Earnings per Share)


by Tim Langeman

Perhaps you have ideas on how this story could be improved. I welcome your suggestions.

I also welcome suggestions about who you think would be interested reading about and collaborating on this issue.



This is a very simplified example of financialization involving only debt and share buybacks at large corporations. More complicated cases can involve some profit growth, executive compensation, and cost-cutting. This story is not about small businesses. It has been simplified to a case of only 7 shareholders for illustrative purposes.


  1. Had you heard how much many USA large corporations’ credit ratings declined in the years before the coronavirus crisis started in early 2020 and that much of their debt was rated just above “junk” status at that time?46 47 NPR’s Planet Money has an accessible and entertaining story on why Credit ratings declined. It was this 9-minute podcast story that inspired me to do the research for this piece.
  2. Did you know that most of the stock purchases made before the crisis were NOT made by pensions, individuals, foreign investors, or hedge funds, but by the companies themselves?
  3. Did you know that over half of companies’ stock buybacks were funded with debt?
  4. Why do you think many large corporations chose to borrow money to buy back their stock rather than invest it for productive purposes between 2012 and 2020? Here are some possibilities to start with:
    • Too much regulation to make investment profitable?
    • Are taxes too high?
    • Too much political uncertainty?
    • Do customers already have what they need?
    • Customers too maxed out to afford to buy more?
    • The company has a mature market position- there is little room to grow. Better to draw down on the company’s credit rating (“mortgage the company”) and redirect the money to other companies with better opportunities?
    • Executives don’t want to take a risk on long-term innovation and growth when low-interest rates make significant short-term debt-driven share price increase a low-risk choice?
    • Perverse incentives reward executives for hitting bonus targets in any way they choose, even if their choices are contrary to the long-term interests of the company?
  5. How would you feel if it turns out that, contrary to conventional wisdom, corporate profits (before taxes) had been flat from roughly 2012 – 2020 and stock prices were inflated with debt?4849
  6. What other political or economic things are being revealed or concealed by the coronavirus?


Background Reading:

  1. Financialization is profit margin growth without labor productivity growth. (by Ben Hunt)
  2. Texas Instruments: a poster child for financialization, the Obama/Trump Zeitgeist: an unparalleled transfer of wealth to the managerial class (by Ben Hunt)
  3. 9 Questions about the Finance System: Was the Pre-Coronavirus Stock Market a Bubble Inflated by “Financial Engineering”? (2014-2020) (by Tim Langeman)


See Linked Spreadsheet for Details of Dopey’s Financial Plan.

(Improve my numbers: download Excel version, tweak and Email me.)



Social Capital CEO Chamath Palihapitiya’s case against stock buybacks, dividends



More that is Concealed:

Federal Reserve enters new territory with support for risky debt

Programme to support ‘junk’ bonds aims to soften blows from coronavirus and downgrades

.. The Federal Reserve has jolted credit markets by expanding the scope of its support measures, announcing plans to buy debt issued by riskier companies in a radical addition to its crisis-fighting toolkit.

Junk Bonds
Junk Bonds by Simon Cunningham

.. Under the programme, the central bank will buy corporate bonds that were rated triple B minus or above — the threshold for a company’s debt to be considered investment-grade — on March 22. That still includes bonds from recently downgraded companies such as Ford, known as “fallen angels” when they lose their coveted investment-grade ratings.

Read More: Financial Times (British)


Obscure Section of CARES Act Provides $195 billion for Wealthy

.. the $2.2 trillion CARES Act passed by Congress last month contains deep within its 800 pages two barely-noticeable tax clauses that only benefit rich Americans, perhaps including the president.

The new tax clauses will cost Americans about $195 billion over 10 years50

Super Yacht: The Rising Sun: Larry Elison & David Geffen
Yacht: The Rising Sun owned by David Geffen
photo by Scott Smith

.. The astronomical cost only became evident a day after CARES was signed into law, when the nonpartisan congressional Joint Committee on Taxation (JCT) published an analysis of the provisions. The committee’s latest findings show that four of five millionaires will pocket an average of $1.6 million more this year alone thanks to the stimulus bill. This of course dwarfs the $1,200 one-time checks average Americans will receive.

In total the tax clauses will cost taxpayers more than the funding allotted in the CARES Act to all hospitals throughout the US, and more than the relief provided to all state and local governments, according to the JCT analysis. Together, they are the costliest elements of the relief package.

Read More: Quartz

Echoes of 2008: They Mistook leverage for genius

Steve Eisman (of Michael Lewis’s book and Movie “The Big Short“)

Steve Eisman: Quantitative Easing was a failure: it didn’t get corporations to borrow and invest. Rather, they borrowed and bought up their own stock. They didn’t really invest in the economy.

In other words, they increased their profits by increasing their debt (leverage) ratio.

(the interview is from 2017)


Steve Eisman: Inequality was a cause of the 2008 Financial Crisis (10:17)

People “levered themselves” (ie took out loans that increased their debt-equity ratio)


Steve Eisman: They made money because they increased their leverage (debt ratio) and they mistook their leverage for genius (12:19)

Creative Commons License
This work is licensed under a Creative Commons Attribution 4.0 International License.

(Most images created by others)



  1. Finance-types refer to borrowing as “leverage” because, like a ‘lever’, it amplifies your effort.

  2. You might wonder why this Federal Reserve chart looks different than upward sloping graphs you are used to.  The first reason is that this graph uses pre-tax figures that do not include the boost that corporate tax cuts gave to the stock market.  The other reason is that this graph is based on total profits, rather than earnings per share.  In the rest of this article, you will learn how corporate debt artificially inflated earnings per share.

  3. The fallout from the prior 2008 financial crisis was not dealt with.  The government bailed out the system and assumed the debt.  Most Americans’ wages had stagnated and healthcare and education expenses have gone up dramatically.  In order to compensate for week customer demand, companies had begun to borrow money and buy back their own stock.  Even with a deficit of $1 trillion/year, pre-coronavirus, the economy grew at a rate of 2.1% and was projected to fall to 1.6% by 2024.

  4. Now with the coronavirus crisis, the federal reserve is buying some of that debt, as well as allowing corporations to issue additional debt at artificial prices.

  5. Leveraged” is just a fancy term used to indicate that financial activity is amplified by borrowing.

  6. Pre-tax Corporate profits peaked in 2014 and have been roughly flat since 2012.  The perception of growth is mostly due to the additional debt (share buybacks) and the  2017 tax cuts (federal government debt).

  7. There are many variations of the Seven Dwarfs’ Names. I’m going with the 1937 Snow White and the Seven Dwarfs animated musical fantasy film produced by Walt Disney Productions

  8. The value of all the stock is equal to the value of all the company’s assets minus its liabilities.

    ( total stock shares = number of shares x share price)

  9. I picked round numbers for this. If you want to help me improve the numbers, see the excel doc in the footer and edit it.

  10. In Place of the Finances of the 7 Dwarfs Mining, Inc., I’ve inserted a Graph above referring to US Corporate Profits before Taxes, as reported by the St. Louis Federal Reserve. Read more about the chart and about “Financial Engineering” that turns this flat graph into a growing one.

  11. While the level of consumer debt was reduced, corporate and government debt went up.

  12. How different would rates have been if the government had not pushed for a late-cycle stimulus and not resisted advice to raise interest rates?

  13. Market Capitalization is the total value of all outstanding shares. Shareholders own what remains after everyone else has been paid (this includes employees, bondholders, vendors, etc)

  14. 7/6 = 1.67

  15. Equity” is what the shareholders own after all the bills (including debt) have been paid. It is the value of assets minus liabilities. The additional debt they took on to buy out Grumpy’s share is a liability.

  16. Disney Fandom: “Aside from his coyness, Bashful also appears to be romantic. He adores the idea of true love, and when Snow White decides to share a story with the dwarfs, Bashful joyfully suggests a love story, which she obliges to.”

  17. 7/5 = 1.40

  18. financial engineering is the use of mathematical techniques to solve financial problems. .. Although financial engineering has revolutionized the financial markets, it played a role in the 2008 financial crisis. As the number of defaults on subprime mortgage payments increased, more credit events were triggered. Credit Default Swap (CDS) issuers, that is banks, could not make the payments on these swaps since the defaults were happening almost at the same time.

  19. Disney Fandom: “However, in spite of spending most of his time nearly falling asleep, Sleepy is apparently the most observant and logical of the seven dwarfs, whether he knows it or not. He was the only dwarf to make the assumption that the Evil Queen may be attacking Snow White at the cottage when the forest animals frantically interrupted the dwarfs’ mine work.”

  20. This is a simplified version of the finances that doesn’t include interest or profit reinvestment. I was concerned that adding them at this point would take away from the broader point.

  21. 7/3 = 2.33

  22. Prior to the coronavirus, roughly half of all corporate debt was rated BBB, which is the minimum “investment grade” rating. A lot of this debt was purchased by the Fed as part of the bailout, including debt that was downgraded to “junk” status.

  23. “Junk” bonds are often referred to as “high yield” bonds. “High yield” sounds nicer and it accurately conveys that these bonds have a higher yield (or interest rate) as compensation for the extra risk the lender takes.

  24. I am deliberately using the British System as a way to distance the reader from drawing favorable or unfavorable inferences onto current American officials. This story is really about the dwarfs (and especially large corporate businesses) and the way they relied on debt to raise their share price.

  25. The Privy Council of the Forest Kingdom is a formal body of advisers to the Sovereign. Its membership mainly comprises senior politicians who are current or former members of either the House of Commons or the House of Lords.

  26. Provinces are like states in the American context. The head of a province is the Premier.

  27. Yes, I know in the British system the Queen would leave this governance to the prime minister but I figure an audience of Americans don’t understand the British system and this version is simpler to explain while taking the spotlight off of particular American politicians.

  28. In some parts of the kingdom the quarantine was applied multiple times to respond to re-occurrences.

  29. Equity” denotes how much their company is worth — how much remains for the shareholders after everyone else is paid.

  30. One might think the debt would be (4 x $1 million)= $4 million. But the actual cost of buying out each share increased as the share price increase: $1 million + $1.28 million + $1.67 million + $2.35 million + bonuses.

  31. For simplicity, I’m using a leverage ratio that uses market cap/debt. A more common ratio is debt/equity.

  32. value of all shares, which is the share price multiplied by the number of shares

  33. Leverage = 7/2 = 3.5

    • I’m assuming a constant total profit of $7 million to simplify this example
    • I’m not including reinvesting profits or deducting interest paid on the debt

  34. See spreadsheet at the bottom of this page

  35. A debt bomb is a situation where a default on a large accumulation of debt can produce major negative consequences not only for the borrower but for many other market participants. That is to say, other people’s debts can harm you even if you were not over-indebted yourself.

  36. .There is more than one type of debt bomb. Banks can become debt bombs. Countries can become debt bombs due to public debt. This is a simplified example of a small business as a metaphor for an entire country.

  37. Low-interest rates make it easier to have more debt and to create “debt bombs”.

  38. 40% of Americans can not afford a $400 emergency. Why should companies invest in increased capacity when consumers’ wages have been stagnant for decades and therefore can’t afford to purchase more products and services?

  39. One can argue that share buybacks are a good way for established companies with limited opportunities to redirect money to shareholders, but does this also apply when companies don’t have the cash but decide to take on extra debt for this purpose?

  40. I’ve heard that leveraged stock buybacks can be thought of as “refinancing,” but refinancing only changes the interest rate of existing debt. These seem more like talking on additional debt for the purpose of converting equity to debt. The average homeowner can think of this as taking out a second or third mortgage on a house. You’re taking on more debt. If the debt doesn’t have a productive purpose it is likely to be problematic.

  41. Yes, profits per share increased because the number of shares decreased, but total profits were flat.

  42. The satirical website “The Onion” provided prescient commentary in 2008 when they published an article titled “Recession-Plagued Nation Demands New Bubble To Invest In”

  43. My goal is to focus on the debt and the circumstances why it was incurred, rather than to focus on Trump (in the American context) or any particular politician, which is why I cast Queen Elizabeth II in the role of queen.

  44. In the Disney series, Dopey does not talk, which does make it a problem if you want to portray him as a “Financial Schemer”

  45. When I talk about large corporations, I’m not talking about small businesses of less than 1,000 employees. The 7 Dwarfs were used as an illustration to make the situation easier to understand, but I don’t mean to include small businesses in this analysis at all.

  46. Roughly half of all corporate debt is rated BBB, which is the minimum “investment grade” rating. A lot of this debt was purchased by the Fed as part of the bailout, including debt that was downgraded to “junk” status.

  47. It is possible that profits are not flat, that they have actually gone up but the unreported profits were siphoned off to tax havens.

  48. Another factor that contributed to corporate share price growth was tax cuts which were “paid for” with additional growth in the national debt.

  49. I don’t know how much money David Geffen will personally get from this bill. I use his yacht as a symbol of the wealth that isolates rich people from the typical citizen and curries favor with the politicians that write, vote for, and sign the bailout packages.

Read Original Source"); ?>

After Blowing $4.5 Trillion On Buybacks, US Execs Demand Taxpayer-Funded Bailouts Of Shareholders

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.

Stocks Like Apple Benenfit from Passive Investment, Even Though Earnings Haven’t Increased Since 2015

SVEN HENRICH: Sven Henrich, been running Northman Trader for about six years.
Originally, private investors, way background was corporate management actually in corporate
strategy internationally, always been looking at companies and opportunities.
Hence, the background and analyzing stock markets comes natural to me.
Our business model is really looking at identifying the big moves.
We’re not day traders where we’re looking at swings, so be it long be short.
Of course, as part of that, we’re looking at the macro environment markets in general–
central banks, what have you, although that’s secondary, the key is technicals and being
able to identify the big turns and that’s what we do.
You see me on Twitter, @NorthmanTrader or on the website,
In April, I had put out a piece called, “Combustion”.
It was this whole notion that both bulls and bears need to be mindful of potentially this
really uplifting scenario.
We had a big turn from the lows of 2018.
We’re literally all central bank policy combusted by them and the view was we’re going to be
raising rates, we’re going to be having a reduction in the balance sheet on autopilot.
Then of course, markets dropped 20% and then yields dropped, actually started the other
way around.
Basically, it was yields heading to 3.2% on a 10-Year in October, and that sparked a whole
selloff in my mind, but basically, central bank’s completely reverted policy.
The Fed had this whole job owning operation all year long from tightening to easing and
rate cuts are coming.
That’s what they’ve been doing all summer long.
In April, what I said was we’re going to keep going on this trajectory until something breaks.
We had a quick correction in May, we had some of the same negative divergences that we have
in the fall.
Something interesting happened here, because we had a temporary high and then we had the
Then in July, we came to a new high and we had a correction.
In June, actually, I had put out this piece called, “Sell Zone,” this was at the end of
June, just before the Fed meeting in July, and the notion was this period, this price
zone between S&P 3000 to 3050 is a sell zone, listed a whole bunch of technical factors
for that.
We had the initial reaction.
It was coming off the heels of the Fed rate cut, the first rate cut since the financial
We dropped from 3028 down to about 2780 on the futures contracts.
A snappy technical reaction.
Then it all started again with trade optimism and more rate cuts coming and so we rallied
again into September.
My view in April was that would be this potential for a blow off top move and the ultimate target
of that was about 3100 as an extreme case.
Now, what I find interesting here is that in September, we got back to this 3000 zone
that I had identified at the end of June as a sell zone, 3000, 3050.
We got another rate cut.
The ECB cut, and we got to 3022, just below the July highs and we dropped again and so
now we have to rate cuts, two drops, potential for double top because we have these all new
highs up and sold in the last year and a half.
There’s not been yet evidence that any new highs are sustainable so markets have been
this wide range.
In 2019, primarily driven by multiple expansion, either by trade optimism, or by the Central
Bank put and my question in general has been, what’s the efficacy?
Is there a sign that central banks will actually start losing control of the price equation?
We’re at the edge of control here.
We’re still in this phase here with the China trade negotiations.
Global macro has been slowing down throughout the year, the US was the island and the sun,
if you will, because global markets actually peaked in January of 2018 and then the US
decoupled from the rest of the world.
Europe, very close to a recession here.
The manufacturing data is maybe now spilling into the services sector.
There is now risk that we’re ultimately going into a global recession into 2020 and what
central banks obviously, have clearly stated, their intent is to extend the business cycle
by any means necessary, and we can talk about that separately.
We’re now at this critical point.
Will we get a trade deal that’s substantive?
By substantive, I mean that actually impacts CEO confidence.
Keep in mind, this whole year and a half year with this trade war going on, companies have
been holding back on CapEx investments, business investments, and now, we’re seeing a slowdown
in hiring.
Remember, with a 50-year low in unemployment, the official unemployment rate, and jobs growth
has been slowing down.
If you get a– and I’ve been very consistent on this, if you get a substantive trade deal
that addresses all the big issues and causes companies to say, “Okay, now we’re more confident
again,” then yes, you can have a massive blow off rally and now, with easing central banks
and the oldest liquidity coming in, you can have that run.
The question is, are these parties really in a position to say we’re going to have a
substantive trade deal?
There does not appear to be any sign of that whatsoever.
We see a lot of positioning, actually this week even, we see China in the US aggravating
the tactical battle, if you will.
China is– in this morning’s indicating they may be open to a partial deal.
What does a partial deal really mean?
Is there probably a relief rally surrounding a partial deal?
We can all speculate in the sense that, “Okay, well now, it’s not going to get any worse.”
It’s a stalemate.
We’ve basically, everybody’s waving the flag.
Mr. Trump wants to get reelected in 2020.
Can’t afford a recession.
The Chinese don’t want things to get worse either.
Everybody’s holding back.
Fair enough.
That could happen, but is it enough to then get confidence back to say, now, we’re ready
to invest when the big issues remain unsolved?
That’s obviously the question that no one can answer.
Now, of course, the flip side to this is there’s not enough that the parties either can agree
to that gives anyone any confidence because keep in mind, all the slowdown has perpetuated
in the last year and a half.
There has not been any sign of slowing down, maybe a little bit civilization in China but
now, the US is slowing down.
In fact, I think it was the Fed’s Rosengren that came out last week, and says he’s expecting
1.7% GDP growth for the second half of the year in 2019.
Not exactly convincing when you have a market that has rallied on nothing but multiple expansion
in 2019.
There’s a lot of risk both to the upside and the downside from my perspective.
On the one hand, yes, there’s some similar elements.
On the other hand, people like to say it’s different this time.
Well, it really is different this time because, look, in the past, we’ve had situations where
we’ve had high debt, and we’ve had yield curve inversions, we had all these things that are
taking place at the end of a business cycle, but never before have we seen so much intervention,
so much jawboning and never before have we come out of a business cycle where central
banks have not normalized in any shape or form.
This is uncharted territory.
I think we’re all– I don’t know what the expression is so maybe we’re all mollified
or pacified in a way because markets have changed so dramatically over the last 10 years
as a result of permanent central bank intervention.
I get it from any investor perspective, because we’ve all been trained, literally trained
to know that any corrective activity in markets is contained.
It’s contained within a few weeks, within a few days, within a few hours.
All bad news is priced in immediately.
We saw it in December.
This was the most substantial correction we’ve had since 2011.
Why did that happen?
It stopped right when Mr. Mnuchin came in with his liquidity calls to banks and with
Mr. Powell flipping policy on a dime.
We’re flexible suddenly.
This is this point where you never have anything that sticks from a price discovery perspective.
My concern in general and the voices in the summer was that we’re creating these markets
that disconnect ever farther from the underlying size of the economy.
Well, there’s two trains of thoughts.
First of all, this is a history part of it.
History actually tells us that the inversion we have on the 10-Year and the 3-Months actually
precipitates a recession every single time.
The question is the timing of which.
Now of course, you have other yield curves.
Some of them which are inverted, some of which are not, but it’s really the point of the
Once that inversion reverts back into a steepening phase, that’s when usually the recession comes.
We’re not at the point yet where that steep learning has taken place.
However, the 10-Year and 3-Months, it’s been inverted for several months now and that’s
typically one of these classic warning signs.
There’s another school of thought that says basically, well, none of this matters anymore
because we have central banks intervening and blah, blah, blah, blah, blah.
I’m not of that viewpoint.
I think the signals are there.
What’s missing for the bear case, frankly, as I called it the missing link is the fact
that unemployment is still okay.
There’s not been a minute where it’s been slowing.
We haven’t seen that flip yet, where companies are suddenly really going into layoff mode.
That’s what interesting looking at Q3 earnings now, because a lot of companies will show
either flat or actually negative earnings growth, which brings me back to this multiple
We’ve been running to market highs, not because of great earnings growth.
Earnings growth is flat to weakening here in this quarter and so companies are experiencing
margin compression.
Then there is that point where they want to start looking at the largest expense line
item, which is jobs.
What’s been so interesting and the reason I kept saying that all new highs are sells
is because all these new highs are coming on specific technical signals and sector divergences.
Especially looking at this year, again, we see– well, last year was basically again,
this was tech, it was Fang-led.
It was the big tech companies.
All new highs came on negative divergences on the technical basis and they were sells.
What was interesting, ever since 2018, the markup of the market has radically changed.
Last year, the banks were leading, the small caps were leading, right into these September,
October 2018 highs.
That has completely changed in 2009.
You overlay a chart with the SPDRs vis a vis small caps and transports and the banking
sector, it’s a horror show.
When we’re looking at the S&P like in September and again, within all-time highs, I can tell
you if you go back to exactly last year, the banking sector small caps and transports,
they’re all down to 11% to 13%.
They’ve not participated.
In fact, they’ve been in months long ranges.
It’s amazing because you see these rallies go up as and hey, people get bullish again.
Then they drop right back to the bottom but the bottom is holding.
Even this week, again, the small caps, transports and the banking sector, right on the edge
of support and they keep bouncing.
Now, I look at this from a technical perspective, I say, “Okay, well, the more often you tag
a certain area, the weaker it becomes either to the upside or to the downside.”
We’ve tagged these areas now multiple times and for a rally to convince, for new highs
to convince and to be sustainable, we need to see those sectors partake and get above
Until I see that, I’m very suspicious of any new highs if we get new highs and from my
perspective, going back to this whole trade deal, unless we see a substantive trade deal,
I view any rallies to new highs as sells because that’s basically what they’ve been doing.
Just one more thought on this whole sector piece, there’s a chart I’ve been publicizing
quite a bit that’s called the “Value Line Geometric Index.”
It’s a fascinating technical indicator because all these indexes are market cap based.
The Microsofts, the Apples, the Amazons obviously have a dominant impact on an index like the
QQQ because they’re worth a trillion bucks each.
If you take all the stocks and put the same dollar value on them, let’s say everyone is
worth 100 bucks, and now track their relative performance, you get a completely different
What we’ve seen since 2018, since the September 2018 highs, is that all new highs that were
made on the S&P come on the lower reading on the value line geometric index.
That’s another one of those signals that tell you, “Okay, these new highs have been a sell.”
See that picture change, then you can have sustained new highs.
To me again, it comes all about efficacy of what the central banks are doing whether we
get a solid trade deal or not.
Because in so far, none of these things have shown any impact or suddenly changing the
growth equation in the economy.
Volatility has been fascinating.
I’ve been publishing quite a few pieces on the VIX in the last few months.
The VIX, I hear this all the time and I keep having to push back.
People are saying you can’t chart the VIX because it’s a mathematical derivative product.
Yes, you can chart the VIX.
In our job, what we do, obviously, we always have to look for what is relevant.
We can all have our opinions.
What markets should do or shouldn’t do, they will do what they will do and what we have
to do is keep ourselves on this and to see what is relevant.
We know a lot of algorithmic trading is part of markets.
They follow programs as well.
You always have to look at, “Okay, what are they looking at?
What are they sensitive to?
What are they reactive to?”
Because we want to be able to interpret risk reward short or long on that basis as well.
What the VIX has done over the last two years is fascinating.
There’s been very specific what I call compression patterns in the VIX, especially on the low
It can drive people nuts.
It can get caught, consolidate on the low end and then boom, you have a spike.
That seemingly comes out of nowhere, but it doesn’t.
It’s in the charts.
I call them these compressing wedges.
Now, what’s been happening on the big picture on the VIX is as the S&P has made new highs
each time, the VIX and the in between periods has made higher lows.
There’s a trend of rising volatility.
Obviously, December last year was the big spike.
It’s the lows, what happens during the lows?
Remember, 2017 was the most volatile compressed year ever because we had global central bank
intervention, we had the upcoming tax cuts, there’s no volatility markets from a trading
perspective, I hate that.
I love volatility, I want to see things move, but now that we’ve had these selloffs, even
the smaller ones, if not been able to contain volatility to the extent that they’ve been
able to do in 2016 and 2017, since 2018, we have a trend of higher lows.
Now, the VIX is again in a compression pattern that suggests the possibility of a sizable
spike still to come this year so we may have one more hurrah before the yearend rally that
we so often see in markets.
I think this whole shift of passive is fascinating.
Maybe a couple of comments on that.
I haven’t seen this discussed anywhere.
Just my impression.
I’m wondering how much of the shift from active to passive investment is actually a consequence
of central bank intervention.
What is driving passive?
Well, you talk about management fees on the active side.
Well, the main driver for the movement to passive is that people have given up.
They see active investors lagging the indices.
Why are they logging the indices?
Because everything is geared towards the big cap stocks.
The intervention– if you’re really careful in analyzing and you’re smart and you have
a smart team, if you diversify in the universe and you get hammered anywhere you lag in the
indices, and passive allocations keep allocating passively.
It’s like this dumb machine that doesn’t care how much it pays.
It doesn’t care what the valuations are, doesn’t care about any of that.
To your point about signaling, yes, it’s amazing when you see– and that’s why I’m coming from
a technical perspective, you see charts that are massively, massively historically overextended
but no one cares because you have this passive machine that keeps investing.
I think I mentioned this last year, too, it’s like, are people actually aware what they’re
competing with?
Because you and I may have a sense of, “Okay, this is getting very expensive,” but a machine
doesn’t care what it allocates.
The ETF doesn’t care what it allocates.
It just has to do rule based.
You’re sitting in the market with entities that don’t care if they overpay.
Classic example is Apple.
Take that stock as an example.
It’s obviously hugely valued.
It’s a big company.
It’s a trillion dollar valuation, but it keeps buying back its own shares.
Obviously, as a big company, it benefits from these passive allocations.
What people don’t realize is that Apple has the same amount of earnings that it had in
Four years later.
Absolutely no change in earnings, same amount of earnings, but people are paying almost
twice the price for the same stock.
Because Apple’s been buying back its shares, therefore reducing the float and save for
the same amount of earnings produced a much higher EPS, earnings per share, bigger.
It looks like it’s growing, but it’s not.
That’s my point about this whole pacified machine that has been created.
You, since corrections are not allowed to take place for an extended period of time,
you’re looking at all of sudden at yearly charts.
We have stocks, as I mentioned before, like a lot of sectors are lagging behind, and the
big cap stocks keep holding everything together because all the money goes towards them.
Because corrections are so short, we have yearly charts that show nonstop gains for
10 or 11 years.
There’s absolutely– the December corrections even show up in these charts because they
were still up on the year in many cases, so you look at Starbucks and Disney.
Disney is a good example.
Up 11 years in a row.
Well, this is this fantasy that’s being propagated now.
Because I just put my money into passive funds, I don’t have to think about it.
It’s risk free central banks always intervene and so we have these massive charts that are
vastly extended.
Even the technical indicator I watch.
On any chart timeframe, you will find this useful.
Be it on the daily chart, the weekly, the monthly, the quarterly and the yearly, it’s
the five exponential moving average.
Even on a daily chart, you see vast extensions above it, it will reconnect either to the
upside or the downside.
If you see massive extensions on the weekly chart, at some point, it will reconnect.
The reason I mentioned this is there are stocks like Microsoft that are 50% above the yearly
five EMA.
Why is that relevant?
Because if you look at the history, look at a stock like Microsoft, you can go back to
its inception and this stock always connect every single year like clockwork.
There were two exceptions, Microsoft, my favorite example.
One was the year 2000.
It was in 1999.
It was completely extended, did not touch the fire a yearly five EMA.
Then the second year was 2001 when it went way above, and then it obviously plummeted
down with the NASDAQ crash and reconnected, and now.
It’s now on its second year, it hasn’t even touched it.
It’s vastly extended.
From my perspective, I look at all this with what central banks are doing here.
I see risk building that these reconnects, technical reconnects, will take place at some
When they do all of these stocks all of the sudden have 30%, 40%, 50% downside risk.
This is the undiscovered country.
It really is.
Look, I’m coming from a training perspective.
I’m resentful of central banks simply because of the volatility compression that they have
aimed to do.
In fact, Jay Powell came out yesterday, made a very telling statement with regards to repo
and overnight money markets.
He literally said we have to calm markets down.
We need to calm.
Where’s that in your charter?
Where’s that in your job description to calm markets down?
Look, markets are supposed to be free flowing in price discovery, but it’s telling because
he has to control that aspect of the interest rate equations, he has to control it.
That’s the point.
Everything is controlled.
When I look at this experiment that has taken place over the last 10 years, and I’m just
absolutely flabbergasted that this is not being pressed more critically by journalists,
by the media and by the public discourse.
QE, lower rates were emergency measures to deal with a crisis.
That was the original intent.
Ben Bernanke, QE1.
Then came QE2, and then twists and turns, then QE3.
It morphed into permanent intervention.
The promise was always we’re going to normalize, becoming come out of financial crisis, everything
that we do, low rates were going to incentivize growth in the economy.
They haven’t.
It was the slowest growth recovery in history.
In the meantime, low rates have enabled this incredible debt expansion.
Now, we also got eyes always glaze over with debt no one even– the numbers have gotten
so big and continue to get ever larger that no one even can fathom these numbers.
Here’s a fun one.
In the last 10 years, the US has added more debt to its balance sheet than in the previous
42 years combined.
That’s this vertical curve we have and there’s no end in sight.
When the Fed, last year, tried to normalize its balance sheet and try to raise rates,
which they managed to get to, basically, the lowest point of raising ever, it all fell
The 10-Year hit 3.2% in October of 2018.
That was the end of it.
The debt construct cannot handle higher rates and so they were forced to capitulate.
My question and the answer to your question is, can they keep this going forever?
Which is interesting to me, coming back to this point I made earlier about valuations
of asset prices vis a vis the underlying size of the economy.
In the year 2000, when the NASDAQ bubble burst, the overall market cap of the stock market
got to about 144% of GDP.
That was it.
It was just too high above the economy.
That’s where the crash happened.
That’s where the recession came.
Then we re-inflated.
This was the lead up to the housing bubble.
Cheap money, who caused the housing bubble?
Well, we can argue it was the Fed with cheap money and this cheap money had to go somewhere
and so we offered credit and subprime mortgages to people who can’t really afford it.
The stock market rose to about 137% of GDP.
Guess where we topped in January of 2018?
144% market cap to GDP.
Where did we top in September of 2018?
146% stock market cap to GDP.
Where did we end this summer in July?
144% stock market cap to– there seems to be this natural barrier that says, “Okay,
well these valuations have to be justified somehow.”
When I now see the Fed saying, okay, well– back in September, where we’re back at 144%,
what are you trying to do here actually?
Obviously, what you have done, what all the central banks have done has not produced organic
growth anywhere near the growth that we’ve seen in previous cycles.
That’s why the ECB still in negative rates and they’re trying to do more than negative
For me, that the question is one of control, efficacy.
Does this produce another lasting jumping an asset prices?
There is no answer to that question yet, but there may be signs.
For me, the first sign was, okay, this July rate cut when we had that sell zone of 3000,
Does the Fed rate cut actually produced sustainable new highs?
The answer to that was no.
Then in September, we had the second rate cut.
Did that produce sustainable new highs?
Yesterday, Jay Powell talked about increasing the balance sheet again, but don’t call it
QE, wink, wink.
We sold off.
Those are those three specific signs, events where the Fed has not succeeded in producing
new market highs or for that matter, new growth.
I think the question is very much outstanding.
Once we know what’s happening with this trade deal, we need to keep reassessing the mechanics
of markets and the technicals and see if we can actually see a sizable turn in the economy.
I’m highly skeptical.
Because all we’re doing is just keep enabling more debt and demographics are not changing
as a result of that.
The deflationary cycle is not changing as a result of that.
Beyond temporary highs, I have to see where that’s producing anything on the macro form,
and so far, it hasn’t.
I think we have to differentiate two things.
The MMT part, it’s your classic capitulation.
We don’t know how to solve any of the world’s problems, because that equation is ongoing.
Because we have demographics that are sending a very clear signal.
Working age population, by the way, I’ve posted out a few times.
I find it fascinating.
For the first time ever, the growth in working age population is actually going negative.
That tells you everything you need to know.
There’s a huge demographic change going on as the baby boomers were retiring, how do
you produce growth with those numbers, unless you believe in some AI productivity fantasy,
which we don’t have evidence for that yet.
MMT to me is the ultimate absurdity of it all.
Free party, free credit.
We keep printing money and there’s no consequences.
MMT adherence will obviously push back hard on this, but even central bankers like Jay
Powell are very much opposed to MMT.
I personally think is a fantasy, as well.
In terms of your question about fiscal policy, can now governments come up with infrastructure
programs or what have you to really push that equation?
This is where I’m going to have a different take on everything.
Now, this brings me back to what we’re seeing in the political sphere in the United States
and the United Kingdom, in Germany, everywhere across the west.
We have social fragmentation, the likes we haven’t seen in our lifetimes, at least.
It’s hard to see political cohesion anywhere.
Germany, for example, used to have three or four parties, not a six, seven and no one
has a majority of any sort.
The UK Brexit is a classic example.
It’s impossible to come to any agreeable solution that’s been going on for years.
The United States is, impeachment aside, what’s happening down that front, this fragmentation
has been going on for at least 20 years.
It just keeps getting worse and worse and worse, and how do you get to a complex policy
solution that enables you to actually implement structural solutions if you can’t agree on
a common reality, and there’s no common reality on anything right now.
Although to be fair, Democrats and Republicans in the US always agree to spend more money,
that’s what we just saw again in this latest budget round.
I remain unconvinced that fiscal– even though I hear Draghi claiming for more fiscal spending,
I don’t see the political cohesion to bring something like that about– German, interestingly,
on a side note, they’re actually running it surpluses.
They’re getting criticized for that, which makes actually, I think Germany really an
interesting place to– if we do have a global recession, what country is actually able to
really deal and stimulate ultimately.
They’ve been very disciplined and holding off on this point, but I suspect they may
have more ammunition than anyone else when we do hit a recession down the road.
How do you see the end of the cycle playing out?
I am actually looking for a yearend rally, because I think what happened in December
of 2018 was superbly rare.
It happened only once before and that was in December of 2000.
That’s how rare these December dumps are.
However, I’m just going by what I know now, and I don’t know what’s going to happen with
the trade deal and this time, the other.
What I do know now is basically what I see in the charts is there’s just another very,
very sizable volatility spike to come.
I can’t tell you when that comes, it would maybe make sense for that to happen in October
or into November.
Then that spike is probably be a buy in markets for a yearend rally, can see that happening.
I expect the Fed to cut rates again in October, maybe throw another one in December.
We’ll see.
I think ultimately, the question is, and I’ve been posting this chart for months now.
It’s this broad megaphone pattern.
If they can get above it, we can have a massive all liquidity and ala March 2000.
It was just crazy blow off the top.
I’m not predicting this.
I’d actually don’t want to see that.
I think stuff like that is just going to be horrid ultimately, because it will just exacerbate
the pain on the downside.
If markets cannot sustain new highs from here, I think going actually back to an earlier
question you asked about historical example, look closely at 2007.
We made a high in July, we made a high in July this year, then the Fed cut rates in
September of 2007.
Because that was their response when subprime was contained.
Don’t worry about– there is no recession.
That’s the same narrative we’re hearing now, there’s not going to be a recession.
The recession came only two months after– three months after the Fed cut rates.
It came in December of 2007, when no one saw or admitted a recession was coming.
After that rate cut in 2007 in September, markets peaked in October, and that was it.
No one– this is the fascinating thing, see, market tops are only known in hindsight with
enough distance.
They’re not apparent or anyone at the time.
That’s why I’m just using that as an interesting example and as a threshold to say we must
make new highs from here or we’re risking, we’re actually made a double top in July and
in September of this year, so I think people need to watch the price action very carefully
from here.
Just finishing up on 2007, when markets made on marginal new high in October of 2007, and
the Fed was cutting rates, Wall Street projected price targets of 1500 to 1600 to 1700 for
All of them.
All of them were bullish in December, not knowing that the session officially actually
started in December of 2007.
The S&P close the year at 800, 880, something like that, cut in half, basically.
I think what we all need to be closely watching for is efficacy of what happens on the trade
front, efficacy on what happens with the central banks and the price action in the charts.
Do we see participation coming from the small caps, transports and the banking sector?
Yes or no?
Will we see sustainable new highs or not?
If we don’t see new highs, risk for double top, watch what the VIX is doing and then
it remains a range bound market for now with opportunities and both sides but I think there’s
some critical thresholds that have taken place.
Punch line, no bull market without central bank intervention.
It remains an artificial construct.
I am worried that all of us have a warped perception of value of what markets should
be doing because, let’s be very clear here, we would not be at new highs in or we would
not have hit these current levels of 3000 in the S&P were it not for complete central
bank capitulation, four rate cuts, jawboning trade optimism, all these valuations have
to be justified at the end of the day.
You cannot lose one of these equations and so markets remain artificially inflated.
The question is if, like in 2000, or in 2007, central banks efficacy loses out.
Remember, they had to cut rates by over 500 basis points to stop the bleeding back then,
and now, they barely have 200 basis points to work with.

Cramer says index fund buying and buybacks are creating a ‘stock shortage’

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.

As employment ticks up and people find more money in their pockets, U.S. investors are becoming more frugal and choosing risk-averse index funds over individual stock-picking, CNBC’s said Tuesday.

“The game has changed since I first started picking stocks almost 40 years ago,” the “Mad Money” host said as stocks rose, bringing the within 1 percent of a record high.

“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.”