Juggling Dynamite

Some $4 trillion in share buybacks by corporations since 2009 have been a indiscriminate force levitating stock prices to valuation extremes this cycle.  It’s also been a non-productive waste of funds enabling asset bubbles, piling on reckless debt and financial alchemy at the expense of long term investment, innovation, strength and stability.  We have been down this destructive road before which led to the banning of buybacks as illegal market manipulation.  And very obviously, we need to ban them again.  This is a huge pillar of the change that must occur to get businesses focused on productive investment once more and stop the debt plague that ails us from metastasizing further.  See more here The end of the low volatility regime (continued):

Until the early 1980s, buybacks were illegal in the U.S. due to concerns executives would use them to manipulate share prices. Today, politicians on both sides of the aisle are threatening restrictions, if not a reinstatement of the ban. Democrats have already made it clear buybacks will be a primary attack point as they seek to sway public opinion about the tax law and take back the House and Senate in the midterms. If rising interest rates and market volatility don’t curb buybacks, politicians may step in and do the job anyway.

One way or another, as the low-volatility regime winds down, buybacks appear destined for a day of reckoning. They have played far too big a role in the QE era not to cause complications as QT progresses. In the words of Warren Buffett: “Only when the tide goes out do you discover who’s been swimming naked.”

The IMF estimated in 2017 that 22% of US corporations were at risk of default when interest rates rise.  No surprise there.  Bankruptcy probability has risen with debt (in red) used for share buybacks (blue) here since 1990.

The elephant of unsustainable pension management has been sitting in the theater of retirement planning for at least two decades.  Now it is taking center stage.  As obligations have soared, contribution levels have not kept up and management has opted for increasingly risky bets in the hopes of ‘winning’ the funds needed.  It’s not working.

Plans that were fully funded 20 years ago, today have maybe two-thirds of the capital needed to cover benefit promises– and that optimistic estimate assumes zero bear markets and fantastical average real returns of 7%+ a year going forward.

The reality of the pension crisis was underlined again last week when the board of the largest $330+ billion US public pension plan, California Public Employees Retirement System (CalLPERS), voted to shorten its period for amortizing future investment losses from 30 years to 20 years. After losing $100 billion in 2008, followed by 10 years of QE-enabled capital markets since, the fund still has not recovered.

The net effect is that state and local governments and agencies will have to further increase mandatory contributions by diverting tax revenues needed for education, health care, roads, environmental protection and other public services.

As warned last summer by Steve Westly, a former California State Controller who served as a fiduciary on the boards of CALPERS and CALSTERS, current pension funding plans are not feasible:

We’re already seeing pension liabilities crowd out other spending. General fund revenues have grown 28 percent over the past six years, but the share available for discretionary spending outside of public safety has declined from 21 percent of the budget to 12 percent.  Over the same time frame, spending on pensions increased 99 percent.

Officials are now acknowledging that if when pensions experience another big investment loss, they will pass a point of no return and be unable to pay their promises.

Since most have responded to falling yields the past 8 years by increasing allocations to risky bets on over-valued stocks and illiquid assets like real estate, hi yield debt, hedge funds and private equity, big losses in the next bear market are baked into the approach.

Solutions include lowering benefit payments and indexing, delaying retirement ages, increasing saving/contribution levels, and in some cases expunging obligations in bankruptcy.  None of these are popular, but this is reality.  See California’s Public Pension Crisis in a nutshell:

Client agencies – cities, particularly – were already complaining that double-digit annual increases in CalPERS payments are driving some of them towards insolvency and the new policy, which will kick in next year, will raise those payments even more…

But CalPERS itself may be on the brink, and the policy change is one of several steps it has taken to avoid a complete meltdown.

Danielle was a guest this week with Jim Goddard on Talk Digital Network talking about recent developments in the world economy and markets.  You can listen to an audio clip of the segment here.