Fed’s Market Distortions Unwind…”Buybacks financially engineered the illusion of business growth despite stagnant sales.”
SilverDoctors.com
January 13, 2016
The world’s financial markets changed dramatically entering this young new year, led by sharp stock selloffs and a mounting gold rally. These are major reversals from recent years’ action. The immediate catalysts were China’s plummeting stocks and ongoing yuan devaluation. But the far larger underlying driver is the Fed’s first tightening cycle in a decade, which is just starting to unwind years of gross distortions.
Submitted by Adam Hamilton, Zeal:
Just a few weeks ago on December 16th, the Fed’s Federal Open Market Committee chose to hike the benchmark federal-funds rate for the first time since June 2006. This was widely hailed as bullish for stocks, since it implied the US economy had improved enough to weather a new tightening cycle. The flagship S&P 500 stock index (SPX) surged 1.5% that day, as traders rejoiced at the Fed’s gradualist approach.
But as I argued a couple days later, that stock euphoria was terribly misplaced. The Fed had originally implemented its zero-interest-rate policy during 2008’s stock panic, and promised ZIRP would only be a temporary emergency measure. But the Fed reneged and kept ZIRP in place for an astounding 7 years. This along with the Fed’s quantitative-easing debt monetizations unleashed a vast deluge of liquidity into markets.
Much of this flowed into stocks, through the mechanism of corporate stock buybacks. Companies took advantage of the Fed forcing rates to artificial lows by borrowing incredible amounts of money. Instead of investing it in actually growing their businesses, they used it to buy back their own stocks. Enormous debt-fueled stock demand from corporations at a mind-boggling scale directly levitated the stock markets.
The Fed’s own data late last year reported that US non-financial companies spent a staggering $2.24t on stock buybacks since 2009. This was 1.8x higher than the $1.24t of stocks purchased by the entire mutual-fund and exchange-traded-fund industry over the same span! Meanwhile pension funds sold $1.05t of stocks, while households and hedge funds collectively liquidated another $0.56t. Think about that.
Since 2009, stocks saw net selling from normal investors of $0.37t. So the only reason the SPX blasted 215.0% higher between March 2009 and May 2015 was the trillions of dollars of stock buybacks. And of that $2.24t, the Fed reports that a shocking $1.9t was debt-financed. That’s over 5/6ths of all the stock buybacks since the panic! ZIRP unleashed the biggest debt-fueled stock-buyback binge ever witnessed.
Corporations love buying back their own stocks not only because that extra demand boosts their share prices, but because of its impact on apparent profitability. Buybacks leave fewer outstanding shares over which total income is spread, raising the critical earnings-per-share metric that feeds into price-to-earnings ratios. Buybacks financially engineered the illusion of business growth despite stagnant sales.
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