US Corporate Buyback Tsunami

July 29, 2016

            One thing about Wall Street is that they can certainly pat themselves on the back with respect to corporate earnings and the rise of the stock market. The initial problem of what most US companies are doing is cutting capital expenditures and using increased debt to increase share buybacks and dividends. All these applauds may be tenuous since corporate debt overhangs and deters investment for future growth; the principal mantra of a rising market.

 

           The principal mantra establishes a milieu of maximizing shareholders’ profits and appeasing analysts’ view of the company, not towards growth, but on their recommendations to lift share prices and to enhance the institutional belief system that all is well. The zero-interest environment will also support many economists’ beliefs that the global economy is more productive as an instrument of monetary policy.

 

            Economists will never consider Charles Darwin because it’s not within their frame of mind to consider the survival of the fittest. The Fed regime is there to purchase additional securities, adding reserves to drive interest rates to zero. US corporate debt stands at $29 trillion. The high corporate debt-to-equity ratio is based on financing growth with debt rather than realigning investment towards global growth. It’s a type of behavior modification that can only be sustained by the public’s perception of higher yield or the quest for yield itself.

 

            These are the expectations of a bull market where share buybacks are most prominent as oppose to bear markets where share buybacks are significantly cut back. Market makers also play a role in the reversals of markets, forcing companies to buy back shares that market makers successfully acquire at lower prices. With buybacks, market makers are able to anticipate a higher price and a higher spread enabling market makers to continue a revolving door of profits between the highs and lows of the market.

 

            Many of the US corporate buybacks become an elusive operational performance of a company; they’re simply boosting earnings per share to increase underlying performance and value.  Rule 10b-18 of the Securities Exchange Commission has granted companies a safe harbor and legality in manipulating the stock market through open-market repurchases. These types of open-market repurchases elevate the market artificially to entice the public to pay a higher price on a false image of how the market really works.

 

            GoPro Inc. is a prime example of a company whose stock price was elevated by market makers to over $90 per share and then dumped by employees who immediately began to exercise their options as they recognized the dangers of competitors fighting against their product line. The employees felt the right to materialize their tangible asset before the survival of the fittest deemed their asset intangible. If the logical rationale from an economic point of view is to use repurchases to offset dilution from employees exercising their stock options, then the logical notion is that employees worked hard for their company and simply want their money now.

 

            The problem with GoPro Inc. is that they were unsuccessful in building productive capabilities to establish their competitive edge in the long-run. Sure, they had a huge organization and some degree of financial advantage, but their failure in recognizing potential investment opportunities ultimately led to their downfall. US corporate elites believe that they’re creating value capabilities. However, what they’re really doing is investing in outstanding shares with hopes that stock prices will rise. It was a sad case with GoPro Inc. where a plethora of analysts raised the value of the stock without merit. It was a disservice among the many individual investors that had absolutely no clue as to what was happening. From over $90, GoPro Inc. now trades at just over $11, a classic story of pump-and-dump.

 

            Corporate buybacks simply work as a heightened incentive to manipulate share prices. The safe harbor stemming from Rule 10b-18 fails to build capital formation or productivity that establishes the well-being of the company. Executive compensation not only undermines physical capital, but also human capital to sustain the competitive edge. The real problem is that it really doesn’t matter whether it’s a bull or bear market. Executives are prone to be on their cell phones 24 hours a day not allocating resources to their company, but trying to sustain higher share prices to eventually unload their options.

 

            These are the reasons why Janet Yellen, Mario Draghi, and Shinzo Abe can not raise wages globally. That’s why Draghi now wants a bailout for Italian banks. He had little sense understanding that the Italian bankers were searching for high-risk individuals that were willing to borrow at higher interest rates with a small probability of repayment. In the end all that mattered was that the bank executives received their options, ain’t that right Mario? That’s what happens with easy money: there are less screening devices and it becomes a natural addictive behavior of channeling money to hidden costs and payoffs.

 

 

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