Before last night’s third series of central banking inspired melt-UP in the US-European stock markets, the Wall Street Journal presented “Clouds Darken for America’s Blue-Chip Stocks” which noted that “A third of the companies in the Dow Jones Industrial Average have posted shrinking or flat revenue over the past 12 months, according to data from S&P Capital IQ. Revenue growth for nearly half the industrials didn’t outpace the U.S. inflation rate of 1.7%.”
But the Wall Street Journal forgot one very important dynamic in the present environment: today’s Fed inspired easing has led to debt financed corporate buybacks—thus the embellishing earnings!
ONE-thirds of the gains in the Dow Jones Industrials last night were supposedly led by Caterpillar and 3M. Notes the Marketwatch.com
Caterpillar and 3M indeed soared by 4.97% and 4.39% respectively. 16 issues of the Dow Industrial components rose by over 1% while only 4 issues declined based on the quotes from netdania.com
Reason? Because both issues supposedly exceeded analysts estimates, according to this Bloomberg report.
For the consensus, quality of earnings don't seem to matter.
For instance, sluggish sales for Caterpillar? No problem. Buybacks has saved the day!
The Zero Hedge quotes Caterpillar (bold mine): “So far this year, we've returned value to our stockholders by repurchasing $4.2 billion of Caterpillar stock and raising our quarterly dividend by 17 percent
Buybacks has recently been instrumental in inflating the US stock market bubble.
The Bloomberg recently noted that 95% of profits from S&P companies have ended up on Buybacks and dividends: “Companies in the Standard & Poor’s 500 Index really love their shareholders. Maybe too much. They’re poised to spend $914 billion on share buybacks and dividends this year, or about 95 percent of earnings, data compiled by Bloomberg and S&P Dow Jones Indices show. Money returned to stock owners exceeded profits in the first quarter and may again in the third. The proportion of cash flow used for repurchases has almost doubled over the last decade while it’s slipped for capital investments, according to Jonathan Glionna, head of U.S. equity strategy research at Barclays Plc.”
So instead of capital expenditures, profits or even debt has been used to pad up earnings.
The above table from Wall Street Journal Money Beat shows of S&P’s 20 biggest companies that have engaged in buybacks. 3M is in the top 20 (red rectangle)
So without capex how will growth in corporate earnings or even in the macroeconomic environment be attained?
Buybacks are nothing more than financial engineering that has vicious side effects on corporate balance sheets. As analyst David Stockman in his examination of the intense buyback resorted by IBM explains at his website
Those munificently rising stock prices and options cash-outs owe much to the Fed’s campaign to suppress interest rates and fuel stock market based “wealth effects”. Yet as the case of IBM so vividly demonstrates, the CEOs are doing their part, too. They have become full-time financial engineers who use the Fed’s flood of liquidity, cheap debt and soaring stock prices to perform a giant strip-mining operation on their own companies. That is, through endless stock buybacks and M&A maneuvers they create the appearance of “growth” while actually liquidating the balance sheet equity and future asset base on which legitimate earnings growth depends.
Using much of retained earnings for buybacks essentially reduces opportunities to grow earnings generically when investment opportunities emerges. Even worse, debt financed buybacks frontloads payback to shareholders in current terms at the expense of the future. Aside from the opportunity cost of investments, debt servicing costs will be a future burden.
In addition, rampant buybacks typically occur during market tops, as hedge fund manager John Hussman recently pointed out: (bold mine)
Buybacks are not a return of capital to shareholders – they are partly a leveraged speculation on shareholder’s behalf, partly a strategy to enhance per-share earnings by reducing share count, and partly a way to reduce the dilution from stock-based compensation to corporate insiders. Moreover, repurchases move in tandem with corporate debt issuance, which is another way of saying that the history of stock buybacks is one of companies using debt to buy their stock at overvalued prices.
Fed policies have transmogrified publicly listed US companies into casinos. Such diversion of resources to unproductive uses will have nasty unintended consequences for both corporate earnings and for the US economy.