I grew up listening to Van Halen. The band’s eponymously named debut album was easily one of the greatest pieces of vinyl to emerge from the late ‘70s to early ‘80s rock scene. And then along came Sammy Hagar to replace David Lee Roth as lead vocalist, and, well, the chemistry died.
The formula was the same: four dudes, a guitar, a bass and a set of drums. But the chemical reaction they catalyzed was something altogether different. I lost interest.
Which is, I acknowledge, an admittedly obtuse segue into a speech Fed Governor Stanley Fischer recently gave at the Aspen Institute. Fischer’s words gathered a good bit of ink, but for reasons unrelated to this week’s dispatch.
The media trained its sights on Fischer’s comments that seemed to indicate the U.S. economy is approaching the Fed’s employment and inflation goals, and, thus, the Fed is nearing the point at which it will raise interest rates again.
I was focused on a different comment — one that explains why the U.S. economy has no traction and why the U.S. stock market sits on a precarious ledge. The chemistry is, in essence, off. An ingredient necessary for economic vibrancy is missing, and this week’s dispatch aims to show you exactly what it is that’s missing and why it’s missing.
Let me quickly dispense with the notion that employment in America is strong. I’ve written many times showing why that assessment is as bogus as a Milli Vanilli concert. (Remember the duo ostracized for lip-synching in the ‘80s?) While the economy has added a fair number of jobs, quantity does not speak to quality.
Every month for the last few years, the preponderance of jobs we’re adding are in low-wage service-sector corners of the economy. Or they’re low-wage white-collar jobs in office administration, education, menial health care and temp agencies. Average pay in every case is below the U.S. median, meaning the ability of the American worker to pursue a consumption-oriented middle-class life is increasingly difficult, which, in turn, is part of the reason our economy (deeply dependent on the consumer) continues to struggle seven years after the recovery began.
But there is a second reason, which the Fed’s Stanley Fischer hinted at in his speech.
He told his audience that “business-sector productivity is reported to have declined for the past three quarters, its worst performance since 1979,” and “productivity growth has been lackluster by post-World War II standards.” As part of the reason why, he said: “Business investment has been relatively modest during the current expansion, and so increases in capital per worker have been smaller than in previous decades.”
English translation: American companies aren’t putting money to work in the economy by investing in their businesses or their employees.
And I have the facts to back up Fischer’s claim.
I pulled all the data on corporate buybacks inside the Dow Jones Industrial Average since 2008. This represents companies that are using corporate profits to buy back company shares.
Basically, companies have a few things they do with the profits they earn: pay dividends to shareholders, invest in the business and/or buy back their own stock.
Well, it’s clear that Wall Street’s preoccupation is itself, not the economy and, increasingly, not even the underlying business.
From the beginning of 2008 through today, the 30 companies inside the Dow have spent $1 trillion buying back their shares. That’s nearly half of the $2.15 trillion in profits they earned.
In the same period, they also paid out just shy of $775 billion in dividends.
Inclusive of dividends and buybacks, the Dow 30 companies have less than 18% of their profits remaining to reinvest in the business or employees.
Recent numbers are even more egregious.
The Economy Manipulation Game
So far this year, the Dow 30 companies have spent $337 billion on dividends and buybacks — 117% of their profits. They’re paying/spending more than they’re earning.
The vast bulk of that money is going to buybacks.
You can see in this chart how much — or, rather, how little — corporate profits are flowing into the economy. After paying dividends and spending lavishly (let’s call it “foolishly”) on buybacks, there’s very little, and often nothing, left for the economy writ large.
Corporate America, as defined by the Dow 30, is, as these numbers prove, simply more interested in enriching itself than bolstering an economy dragging its butt along the pavement.
Buybacks so far this year, at nearly $200 billion, are higher than the entire amount spent on buybacks in six of the last seven years — and just barely below the record $209 billion spent in all of 2014.
This is a problem because buybacks offer no benefit to the economy. They serve only two purposes:
- To financially engineer higher earnings per share than a company would otherwise report. That, in turn, artificially lowers the P/E ratio, making a company and the overall Dow seem less expensive than it really is relative to what’s really going on inside the businesses.
- To generate bigger paychecks for executives — and this is one of the greatest flaws on Wall Street and something that both regulators and shareholders and their advocates must address soon if they want to deal with income inequality in America and why slack business investment, as Stanley Fischer pinpointed, is hurting the broader economy. Bonuses are largely based on earnings-per-share metrics. And it is wildly unfair to shareholders that management can monkey with numbers to goose earnings that, then, provides management with even more money. Better if the metrics were based on business-growth measures not so easily manipulated.
To me, the worst part of this buyback spending binge is that boards of directors are approving share repurchases at insanely expensive, questionably justifiable prices. Stocks have been this expensive only a few times in history — just before the Great Depression, in the late ‘90s during the tech boom and just before the Great Recession.
Each of those, clearly, ended quite badly.
To give you an idea of what this manipulation looks like, consider one of the most egregious earnings manipulators — Travelers (the insurance company).
Since 2008, Travelers’ sales have grown by a spectacularly mediocre 1.5% a year since the 2008. Yet earnings per share are up 93%. Incredible!
Only it was sleight of hand. Travelers reduced its share count over the period by 48%. Reducing shares by half allowed the company to essentially double earnings on a business that didn’t grow much at all.
Travelers’ P/E ratio would essentially double to 21 from 11, way too expensive for a company where net income has actually declined on sales that barely progressed.
So that’s what’s really going on in the economy and on Wall Street.
It’s why I say a reckoning is close at hand. Manipulators can monkey with the system for a while. But sooner or later, the system repairs itself. And from this level of overvaluation, the repairs are going to be quite painful indeed.
Until next time, good trading…