Juggling Dynamite

Corporations buying back their own shares was the largest source of equity demand manufactured in the 2009 to 2019 expansion cycle. Borrowing funds to do so was the go-to genius financial gimmick to boost prices and earnings per share.

It is also one of the main reasons that publicly traded corporations are today at record indebtedness and so ill-prepared for the economic shock at hand.  Many are already, hat in hand, asking for taxpayer-funded bailouts, and taxpayers are rightly demanding that a ban on buybacks be part of any aid given.

In a recent Fox interview, President Trump explained that the US $2.2 trillion emergency funding package “could go up further because we’re going to help Boeing and we’re going to help the airlines.”  He also added that there are many companies that were “in great shape 3 weeks ago all of a sudden they’re, you know, struggling for survival. These are companies that never thought about survival.”

It is critical to understand that companies who did not think about survival and piled on record debt to waste billions on share buybacks were not “in great shape 3 weeks ago” and their managers should be fired, not rewarded with bailouts and bonuses.

As I have explained in the past, we have seen this destructive behaviour increasingly over the past 38 years.  Buybacks were appropriately banned as illegal market manipulation for 50 years before 1982.  Since then, companies have repeatedly magnified market swings and vaporized capital by buying back most near cycle tops and then least near cycle bottoms (when prices are most attractive). We are now seeing the enormous downside of this practice once more, as noted by Goldman Sachs this week:

The Goldman analysts also warn investors of another headwind for equities going forward: greatly reduced corporate share buybacks. They point out that nearly 50 U.S. corporations have suspended existing share repurchase authorizations in recent weeks, “representing $190 billion in buybacks, or nearly 25% of the 2019 total.”

Goldman also notes that big rebound days are typical of bear markets, offering the chart below of the six 9 to 19% bounces in the S&P 500 during its 50% decline during the 2008-09 bear market.

Since so many companies, households, pensions, hedge funds, private equity and other investment funds came into this downturn with tons of leverage and low net cash, they are all scrambling to raise it now.  So long as this continues, ‘sell the bounce’ is likely to be a better call than ‘buy the dip’.

Travelling in Spain over Christmas, I came down with terrible flu: head and body aches, fever, violent dry cough, exhaustion. I was on the couch for a few days and coughing for a couple of weeks.  I did not pass it on to my family, amazingly, and I think this suggests it was not a coronavirus.  But knowing now that COVID-19 was spreading from at least mid-November, many people are wondering about virus symptoms they had last fall.

Mid-November in Wuhan, China, and cases of a strange new flu start surfacing. In a sprawling city of 11 million people, the coronavirus, our invisible brutal enemy was born – festering at least a month and a half before the world was told. In January President Xi Jinping made a decision that would ultimately condemn the world: allowing 5 million people to leave the epicentre of the virus without being screened.  Here is a direct video link.

Today as the Bank of Canada follows other G7 nations in slashing its policy rate to the .25% low of the 2008 financial crisis, it also expanded its bond-buying programs to include the recently frozen commercial paper market.  Borrowing costs for corporations at record indebtedness have spiked just as revenues are vaporizing–this is not a good combo.  See the Bank of Canada press release here.

For those who were encouraged by yesterday’s bounce in markets and thinking that bottoms are in and a V recovery is in the works, you might also wish to plan for other possibilities.  The financial challenges at hand are structural/secular and go far beyond containing a virus.  See Nouriel Roubini’s latest Project Syndicate article, here’s a snippet:

While most self-serving commentators have been anticipating a V-shaped downturn – with output falling sharply for one quarter and then rapidly recovering the next – it should now be clear that the COVID-19 crisis is something else entirely. The contraction that is now underway is looking to be neither V- nor U- nor L-shaped (a sharp downturn followed by stagnation). Rather, it looks like an I: a vertical line representing financial markets and the real economy plummeting.

…Unfortunately for the best-case scenario, the public-health response in advanced economies has fallen far short of what is needed to contain the pandemic, and the fiscal-policy package currently being debated is neither large nor rapid enough to create the conditions for a timely recovery.