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What Can’t Go On Won’t Go On, Part 1: Corporate Leverage

By now everyone knows the corporate share repurchase story, about how major companies are engineering higher per-share profits and share prices by buying back their stock and raising their dividends. But just how much they’re spending may still come as a shock.

Today’s New York Times quotes Laurence Fink, CEO of mutual fund giant of BlackRock, bemoaning the short-sighted behavior of his peers: “Mr. Fink noted that companies in the Standard & Poor’s 100-stock index are paying out 108 percent of their earnings to shareholders.”

That’s a lot of cash flowing out the door, and leads to the obvious question of where the excess is coming from. This morning Bloomberg provided the answer, via a chart from Citigroup analyst Stephen Antczak, which is of course that they’re borrowing it:

Corporate leverage 2015

Gross corporate leverage for both investment-grade and junk borrowers is at record levels, and defaults are, not surprisingly, now projected to start rising. The implication: borrowing terms are going to become a lot less favorable, staring with low-quality names and then moving up the ladder to the Blue Chips doing most of the repurchasing. Says Citi:

“The robbing Peter to pay Paul dynamic that has dominated the investment landscape in recent years may be coming to an end as the credit cycle begins to turn and a meaningful pickup looms in the corporate default rate.

Recent conversations that we’ve had with equity [portfolio managers] suggest that they have become far more focused on revenue growth, and are placing far less of a premium on any financially engineered EPS growth. The fact that a basket of stocks that [has] been reducing shares outstanding is meaningfully underperforming the S&P 500 on a beta-adjusted basis suggests that this view may not be that of just the investors we talk to, but far more broadbased.

Corporate buyback share performance 2015

Now the question becomes what, if anything, takes up the slack when corporations stop buying back their shares. One candidate is an inflow of foreign capital fleeing the even bigger messes now being made in China and Europe. But barring that, US share prices will have lost a huge source of support.

7 thoughts on "What Can’t Go On Won’t Go On, Part 1: Corporate Leverage"

  1. I think Armani should go into the Orange Jumpsuit business for the prison outfits that most of the Corporate Officers in America that have engaged in this tomfoolery should be fitted for. And I do think that this Collapse will be so bad that politicians will attempt to deflect blame on anyone with a pulse to keep their heads out of the guillotine. The public will take to the streets this time around.

  2. “Now the question becomes what, if anything, takes up the slack when corporations stop buying back their shares”?
    The answer is nothing. By then I suspect we will be knee deep in QE4 and or NIRP. Thus we will not be to attractive to foreign investors either.
    When this happens I suspect the gig will be up.

  3. I’m awaiting the next dozen or two IBM types of investigations. Not like anyone ever seems to do jail time, but it’s still interesting when they catch the rats at the help of a sinking ship.

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