“Buybacks”…What they do to the markets

AS MOST OF YOU ARE INTERESTED IN GOLD AND SILVER MINING STOCKS, A MAJOR OBSTACLE HAS BEEN THE FACT THAT THE LARGE CAP INDUSTRIAL STOCK MARKET (DOW INDUSTRIALS AND THE S&P 500) HAS NOT EXPERIENCED A BEAR MARKET WHILE THE MID-CAP AND SMALL CAP MARKETS HAVE. COMMODITIES MARKETS AND GOLD AND SILVER STOCKS GENERALLY HAVE BULLISH PERIODS WHEN THE LARGE CAP INDUSTRIAL STOCKS HAVE BEAR MARKETS. THE BROKERAGE  INDUSTRY FIGHTS ACKNOWLEDGING A BULL MARKET IN COMMODITIES AS BROKERAGE PROFITABILITY PLUNGES AND THERE IS NO WAY THAT THOSE PROFIT DECLINES CAN BE REPLACED BY THE SAME LEVELS OF  PROFITABILITY IN THE COMMODITIES MARKETS.

The following article is from Doug Casey’s Daily Dispatch, a superb advisory service. The article is quite informative as so few are aware of the devious use and power of “buybacks” 

          With all these warning signs, you may be wondering why U.S. stocks haven’t tanked yet…

The answer is simple. Although “mom and pop” investors have been dumping stocks, U.S. corporations have been buying their own shares at a near-record pace.

Bloomberg Business reported yesterday:Standard & Poor’s 500 Index constituents are poised to repurchase as much as $165 billion of stock this quarter, approaching a record reached in 2007. The buying contrasts with rampant selling by clients of mutual and exchange-traded funds, who after pulling $40 billion since January are on pace for one of the biggest quarterly withdrawals ever…

Should the current pace of withdrawals from mutual funds and ETFs last through the rest of March, outflows would hit $60 billion. That implies a gap with corporate buybacks of $225 billion, the widest in data going back to 1998.

Since 2009, S&P 500 companies have shelled out more than $2 trillion on share buybacks. A share buyback is when a company buys its own stock from shareholders.

Buybacks reduce the number of shares that trade on the market. This can boost a company’s earnings per share, which can lead to a higher stock price. But buybacks do not actually improve the business. They just make it look better “on paper.”

Buybacks are about the only thing keeping the stock market afloat. As you can see in the chart below, the S&P 500 has gone nowhere since September 2014.

• Borrowed money has fueled the buyback craze…

Dispatch readers know the Fed has held its key interest rate near zero since 2008. It’s made it comically cheap for U.S. companies to borrow money.

In 2008, a corporation with good credit (an “A” credit rating) could borrow money in the bond market at around 6.0%. Today, these companies can borrow at 3.1%.

As a result, U.S. corporations have loaded up on cheap debt.

The Securities Industry and Financial Markets Association reports that U.S. corporations have issued $9.7 trillion in new debt since 2008. Last year, U.S. companies issued more than $1.5 trillion in new debt, which set a new all-time high.

Many companies have used this borrowed money to fund share buybacks. Reuters reported in September:

Interest rates at near zero have increasingly prompted companies flush with cash to issue debt to fund share buybacks. Apple Inc., for instance, has issued $23.6 billion in debt this year despite having more than $200 billion in cash, part of its plan to buy-back up to $140 billion in shares by the end of March 2017. MetLife Inc., meanwhile, sold $1.5 billion in bonds in June to fund share buybacks, while having more than $10 billion in cash on its balance sheet.

• The buyback mania helped push stock prices to record highs…

But remember, individual investors are no longer buying stocks. Corporate America is the only buyer still standing.

Buybacks can only prop up the market for so long…

As we said earlier, corporate earnings are drying up. The last two major earnings droughts sparked huge declines in share buybacks. Bloomberg Business reports:

During the last two decades, there have been two times when earnings contractions lasted longer than now. Both led companies to slash buybacks, with the peak-to-trough drop reaching an average 62 percent.