December 6, 2014 Buy Backs

Risk/Reward Vol. 245

THIS IS NOT INVESTMENT OR TAX ADVICE. IT IS A PERSONAL REFLECTION ON INVESTING. RELY ON NOTHING STATED HEREIN.

DUE TO THE PRESS OF OTHER BUSINESS, THIS WEEK’S FORMAT HAS CHANGED. ONE LYRIC AND ONE REFLECTION IS ALL YOU GET.

“I think you will find/When your death takes its toll
All the money you make/Will never buy back your soul.”---lyrics from “Masters of War” sung by Bob Dylan

Domestically, we see a good jobs report, an "ok" wage growth number and inflation in check. But internationally, China, the emerging markets and Europe are on downward trajectories. The US economy by itself may justify an average year in the stock market, say a 7% return. So why is the S&P 500 headed to another double digit gain in 2014? Moreover, how can the stock indices continue to rise year after year when equity (stock market) exchange traded funds and mutual funds have experienced a net OUTFLOW of over $100billion in the past five years? (See Friday’s Financial Times for these and other statistics cited herein) Why hasn’t this outflow of "all the money" “taken its toll” on share prices?

The answer lies, in part, in the number of massive share “buy backs” which are underway. These buy backs (corporations purchase their own shares on the open market thereby reducing the total number of shares outstanding and increasing their all important earnings per share) are how Corporate America has decided to deploy its excess capital. For example, Apple (AAPL) spent $45billion in share buy backs in just the past 12 months. And mega companies are not the only ones involved. In the third quarter of 2014 alone, one fourth of all of the companies constituting the S&P500 reduced their share count via buy backs by at least 4%! Assuming each’s multiple remained constant, this effort alone would account for a concomitant per share price increase. According to Friday’s Financial Times, Corporate America's buy back pace of $40-50 billion per month experienced during the first 10 months of 2014 is likely accelerating even as I write. So it's no wonder stock prices continue to rise.

How long will this continue? With cheap credit plentiful, with world wide economic growth faltering, with populations dwindling (did you read this week that the birthrate in the US is at an all time low of 1.86 births per woman of child bearing age) , with corporations balking at dividends as a means of returning capital and with increasingly pro-active shareholders, I see a protracted period of substantial share buy backs. The simple truth is that corporations are long on cash and short on product demand. Enjoy it while it lasts. But be mindful of what Dylan preaches,

"As the present now/Will later be the past/The order is rapidly fadin'
And the first one now/Will later be the last/The times they are a-changin' "