Friday, February 16, 2018

Corporate Stock Buy-Backs Gone Wild

Spring break is an annual ritual for many in college.  A time for carefree abandonment where you are sure you are invincible and the crowd is your biggest ally.  And when I think about what is going on in the stock market as 2018 spring break approaches, I cannot help but imagine a large band of C-Suite Executives leading the party this year.  With the Tax Bill passed last December, corporate pockets are flush with extra cash, and they are just looking for a way to spend it.  According to President Trump, they are going to do the responsible thing - they will invest it in plant and equipment and create American jobs and the economy will flourish.

But Spring Break has never been about doing the responsible thing.  It is more about doing the irresponsible, and pushing it to the limits.  And in the year of freebies being released from Washington in the hope of responsible behavior, there is this Pollyannaish notion that the adults in the C-Suite will do the right thing.  Well optimism would be well founded if you believe that doing the right thing is taking the tax-cut windfall and continuing the trend of buying back your own company stock.

According to Bloomberg Intelligence, corporate buybacks are likely to jump 75% to $850B in 2018 after the passage of the Tax Reform Bill.  This would not only continue an already hot trend, but accelerate the activity to a new level well beyond the high reached in 2007.  And, in case you missed it, 2008 and 2009 came after 2007.

Which raises the important question, is excessive corporate buyback activity signs of a healthy stock market and therefore considered responsible behavior? 

Monday, February 12, 2018

Careful Buying the Dip after the Correction, You May Become the Moth to the Flame

In my latest financial market perspective article, Warning: Market Rout In Progress, Investor Discretion Advised, written on Thursday, February 8th after the stock market closed in ‘official down 10% correction territory’, I stated a view that the market would now be tested and a sell any rally (SAFR) rather than buy the dip (BTFD) psychology was likely to emerge.  The biggest challenge in the market in holding the recently achieved highs is that the broad stock market valuation has been driven well beyond its supportable valuation range given the size of the US economy and its current growth capability.   

The main reason that stocks have been able to move up to the high point it reached it reached on January 26th, 26,617 on the DJIA (DIA) and 2873 on the S&P500 (SPY), is the combination of extraordinary world central bank monetary stimulus over the past 9 years combined with the tremendous hype behind a new US government economic plan.  

The extremely fast move in the market into correction territory the first week of February is a sobering reminder to investors that there are pent-up speculative pressures embedded in the market that will need to be unwound as monetary stimulus is unwound.  This process is very likely not over after just 9 trading days.

Friday, February 9, 2018

Financial Market Jury Is Out On The Trump Economic Plan

Senate leaders unveiled a two-year budget deal on Wednesday, February 7th, 2018 that created a compromise in the heated budget negotiations between the Republicans and Democrats.  Less than two months after their $1 trillion tax cut, the House passed a resolution the following day that raised budget caps by $300 billion in the next two years, increased the debt ceiling and offered up more than $80 billion in disaster relief for hurricane-ravaged Texas, Florida and Puerto Rico.  President Trump signed the bill into law on Friday. 

There really is not any way to fund all the Trump budget requests without higher government fiscal spending given the Senate rules.  Once the Republicans put forward higher spending increase requests for their favored military lobbying constituencies, the democrats countered with their own increase requests.  In order to get the 60 votes required to pass the budget, the outcome was predictable.

What is so misleading about the whole situation is that the actual fiscal spending increase rate, in absolute terms over the past decade has only been 3.6%, and an even lower 2.6% over the past 4 years.  You would think with all the hype it was growing at 10 times that rate.  But, it is very telling about the economy in general when you look at the growth rate in fiscal spending over time, and its relationship to generating inflation (the debt also has a big impact, depending on where the debt is financed foreign versus domestic).

I have a table I recently created from some of my research I think you will find interesting.

You can draw your own conclusions from the data, but what I see is a country that has cut its tax base so far, that it cannot grow the government fiscal spending machine without borrowing more and more debt.  The trending result is lower domestic GDP as both real growth and inflation driven price pressures have moved lower through time. 

Slowing the Washington spending machine down in absolute growth terms, turning the FED loose with monetary stimulus (the Obama result), but without a large increase in the public debt from the end of 2013 until today (all the new debt occurred in 2009 and 2010, and much of it was consumed by the Fed and China) produced a hyper-inflated stock market, but tepid U.S. economic growth.

The Trump plan is changing the entire playing field - more fiscal spending in absolute and % terms, possibly a lower FED effective balance sheet (but definitely a lower absolute balance sheet as they allow Treasury holdings to run off their balance sheet) which means higher interest rates, and much higher growth in the US public debt.

I leave a question mark on the GDP forecast in the table because the jury is definitely out on how this new path will play out.  But I do know the realization of how this plan will actually be implemented in the financial markets is hammering longer term bonds, stocks and the US Dollar as of the first week of February 2018.  On a relative basis, the Trump plan might end up pushing the economy back toward an era similar from a mathematical perspective in relative terms to the 1970s. There is hope it will be the 1980s in the market, but I think the starting point for stock and bond valuations is too high.

Here is a look at what has happened to the stock market over the same periods covered in the table above.

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Daniel Moore is the author of the book Theory of Financial Relativity.  All opinions and analyses shared in this article are expressly his own, and intended for information purposes only and not advice to buy or sell.