X22 Report Spotlight

X22 Report News Flash

US Debt

national debt

X22 Report

Keep Your Grubby Meat Hooks Off

Original newz story - Click here

With all the talk of stock market manipulation in China and the ridiculous politics of Europe, it’s time to bring both concepts together with something closer to home.

Stock buybacks are certainly nothing new, either to financial news or to anyone who has read my previous articles on the dangers involved.

However, though it may only be in a nascent phase, I simply cannot stomach the attention they are now receiving from politicians.

Senator Elizabeth Warren has referred to buybacks as stock manipulation. Now Senator Tammy Baldwin has even gone so far as to call on the Security and Exchange Commission to take a hard look at the practice.

As much as I hate buybacks gone wild, the very last thing I want to see is politicians inserting themselves into the mix.

There is a better way, and to make it blatantly obvious why, let’s dig in.

The Situation

Here is a quick recap of what is going on here that is drawing the attention and ire of the liberal senators. If you’ve got this down, hop on over to the next section.

There are two straightforward ways to spend excess corporate cash. One is through capital expenditures, such as buying new equipment, hiring staff, and building more or providing services to more clients.

The second is to just straight up buy shares. If you’re going to do this, you can buy another company, or just invest in the broader market.

Or you can have your cake and eat it too. The board of your company can authorize itself to buy back its own shares from public markets.

The first option is harder and better, especially in the long-term and in the economic climate we’re about to enter.

Growth is persistently low (aka “The New Normal,” add “New” as many times as you want) and interest rates are going to climb, at least in the U.S.A.

This is how a company grows revenue. More stuff, more offices, more clients. If they manage the company well and chase good opportunities, they maintain or grow their profit margin.

Classic Business/ Econ 101 stuff here. No big surprises, just rolled up shirtsleeves and a long slog.

However, the second option, even though it often hinders long-term growth potential, is very attractive right now. It is a short-term thumb on a scale, and that scale is the earnings per share ratio.

Near-zero interest rates mean you can take out cheap corporate loans (bonds), reduce the number of shares traded in the public market, and boost your EPS ratio by reduction instead of addition.

After all, the EPS equation is simply earnings divided by number of shares. If you don’t see a way to boost earnings — either through incompetence or genuine worries about capacity to increase return on equity — you simply can reduce shares for the same effect.

Then you pat some backs, thank your team for its hard work in making you look better (be sure not to name them so you retain credit), and go get some cocktails. Huzzah!

The Non-Political Problem

To get an idea of how rampant dependence on this corporate crutch has become, here is the heart of the matter in two sentences and a graph from Goldman Sachs.

Corporations have issued over $18 trillion worth of bonds worldwide since 2008. Currently outstanding corporate debt has risen over 50% to about $10 trillion over the same period.

GS buyback chart

Stock buybacks this year are expected to hit a level only surpassed in 2007. At the same time, the amount of total cash used for these stock buybacks is steadily climbing, only exceeded from 2005 to 2007.

I’m not surprised that politicians are latching onto this topic. It has gradually crept more and more into the mainstream financial news as the situation has gotten worse over the years.

However, the argument being made is weak, and the absolute last possibility for a fix is political.

Sen. Baldwin stated in her letter to the SEC, “There is mounting evidence to suggest that buybacks have a negative effect on jobs, wages, and investment.”

Think about this for more than a minute and you’ll realize any political solutions are too flawed to ever work. They will ultimately undermine the original goal.

Is a job creation mandate in order? We could cap automation in manufacturing, reviving the Luddites to some extent, and destroy return on equity. Investors will flee to companies with better margins, people will get fired, wages will drop.

Are mandatory wage controls and increases necessary? The incentive to work hard and well is removed. Wages will only grow at the government-mandated minimum regardless of personal merit.

Politicians persistently overspend other people’s money (taxpayers) to win over voters, and the trend will undoubtedly extend to the private sector.

Interest payments climb inversely to creditworthiness, squeezing cash flows, reducing investment, reducing the ability to compete. Jobs are lost, wages crater with it, and voilà, now you’re a failed halfway socialist state.

The only possible thing that wouldn’t blow up in our faces is a proportional cap on buybacks, but it is still an egregious intrusion.

The government already taxes businesses to the point where over a trillion bucks are parked overseas. Now it will decide how companies spend what is left over too?

Forcing a company to invest in capital expenditures when there is not a solid reason for it to boost return on equity will only hurt the company in the long run. Thus, jobs, wages, and investment, too.

Let the Free Market Be Free

The simple reality is that investment follows the most efficient use of resources that creates the strongest profits at the time.

In the current climate of near-zero interest rates and weak economic growth, stock buybacks are going to be a large part of how companies allocate cash, whether earned or borrowed.

However, jobs and wages aren’t where to start. They are a symptom of the health of an economy, not the cause of it.

To get a lasting solution without insane unintended consequences, we have to start from the bottom — interest rates set by the Fed

Remove the lopsided incentive to use near-free debt for buybacks and companies will be forced to adapt and compete in a different way to fulfill their mandate to deliver profits to owners (investors).

The only role government (and the Fed, which isn’t, but kind of is part of it) can play here is to set the basic conditions and watch the situation evolve.

It isn’t the producer. It isn’t the director, or an actor, or the paying audience. It is just the carpenter who builds the stage.

Senators Warren and Baldwin need to realize this, focus on their role, and keep their grubby meat hooks off of a system that will only suffer from their manipulation.

Take Care,

Adam English

Adam English

follow basic @AdamEnglishOC on Twitter

Adam’s editorial talents and analysis drew the attention of senior editors at Outsider Club, which he joined in mid-2012. While he has acquired years of hands-on experience in the editorial room by working side by side with ex-brokers, options floor traders, and financial advisors, he is acutely aware of the challenges faced by retail investors after starting at the ground floor in the financial publishing field. For more on Adam, check out his editor’s page

*Follow Outsider Club on Facebook and Twitter.

SanFran MoneyShow