Wasington, D.C. -- (ReleaseWire) -- 05/27/2015 --It feels like the Dow and the S&P 500 are bulletproof, doesn't it? Nothing seems to be able to burst this bubble. Fears of Greek default? No problem. Possible rate hike? Nothing. Oil volatility? Bounces right off. Geopolitical concerns? Russia's actions in Ukraine? Continuing sanctions? Bring it on—it just doesn't matter!
In nearly every show, we point out the glaring disconnect between aggressively negative equity flows and record highs of the S&P 500 and the Dow. The question comes up over and over again: who or what is this bubble dependent upon? Of course, the first and most obvious answer is the Federal Reserve's ongoing Keynesian experiment, which treats our economy and our own personal financial lives as the largest economic petri dish in history. The experiment is failing. April 2015 data is coming in, and we're at an absolute low in terms of macroeconomic indicators, worse even than in the aftermath of the Lehman Brothers crisis. One of the most confounding things to watch is employment numbers. When the April jobs report came out a few weeks ago, it showed that the number of Americans not in the labor force rose once again, to 93 million. Part-time jobs soared, because that's all people can find, and the number of of full-time jobs tumbled by almost 252,000, the biggest drop in nearly a year. Wages have been as flat as a pancake for the past six years, and the April numbers showed near zero percent wage growth for 83% of US workers. This despite constant talk from the White House about job growth and a healthy economy. As the British author G.K. Chesterton said, "It isn't that they can't see the solution, it's that they can't see the problem." Isn't that simply odd, when the problems are so obvious to us?
The Fed's actions aren't the only thing wrapping armor around the equity bubble, though. A recent research report from Goldman Sachs tells us that, of the 362 companies that have now reported first quarter results, which represent more than 80 percent of the S&P 500 market cap, the majority are involved in buybacks, which of course also provide support for the markets that is independent from the underlying fundamentals. And remember, buybacks are balance sheet leverage, so these companies are creating the leverage to repurchase their own shares.
A few weeks ago, J.P. Morgan took an in-depth look at buyback trends. One example was Apple's announcement of an expansion of its dividend and buyback scheme—they have promised to return $200 billion to shareholders by the end of March 2017, up from a previous figure of $130 billion. And even though Apple is one of the companies with clean numbers and plenty of money on their balance sheets, it certainly does add to the flurry of share buybacks, which have doubled globally led by U.S. companies, which are tracking a year-to-date pace almost 2.2 times greater than last year's.
Goldman estimates that $1 Trillion will be spent on dividends and buybacks this year, 13% more than last year. To give some perspective, that figure is 50% higher than combined projected capital expenditures, 4 times projected spending on Research and Development, and 5 times projected spending on Mergers and Acquisitions.
All that money may keep stock prices high, but a buyback-fueled rally must come at a cost if it is not driven by economic fundamentals. When corporations issue debt to repurchase shares, they're taking on interest expense rather than investing in the future growth they will need to service their growing piles of debt. Buybacks support the market rally, but at the same time inflate earnings per share by reducing the number of shares on the market. It also, unfortunately, enriches management teams in the short run, while not looking to the long haul. So, leveraging ends up as an engineering strategy this simply isn't viable for producing sustainable growth in corporate value and profitability.
We must ask, then: why are companies spending so much money on dividends and buybacks instead of capital expenditures, R&D, and M&A? Perhaps the answer is that they're just not seeing good ways to put all that capital to work, which should tell us all something about future growth expectations for the economy as well as the markets. Buying shares when undervalued can be hugely value-creative for existing shareholders, but the opposite applies when they are over-valued, which is where we are now. The market bubble may be wearing a bullet-proof vest, but in the end it's the air that keeps a balloon inflated, and as the air continues to leak out of our economic fundamentals we should be prepared for the consequences.
All data sourced through Bloomberg
Securities offered through Western International Securities, Inc., Member FINRA & SIPC. Bennett Group Financial & Western International Securities, Inc. are separate and unaffiliated companies.
About Dawn Bennett
Dawn Bennett is CEO and Founder of Bennett Group Financial Services. She hosts a national radio program called Financial Myth Busting http://www.financialmythbusting.com
She discusses educational topics and events in the financial news, along with her thoughts on the economy, financial markets, investments, and more with her live guests, who have included rock legend Ted Nugent, as well as Steve Forbes and Grover Norquist. Listeners can call 855-884-DAWN a as well as take podcasts on the road and forums for interaction.
She can be reached on Twitter @DawnBennettFMB or on Facebook Financial Myth Busting with Dawn Bennett or firstname.lastname@example.org