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Share Buybacks

If you want to know why the US stock market has been so strong over the last couple of years there are two standouts; QE and share buybacks.

The first is general background noise - if you pump enough  money into the system it comes out either in wage and price inflation or in asset prices. It has been asset prices this time. The second is much more direct: if you buy enough shares the price of those shares go up. 

There is nothing intrinsically wrong with buybacks. If a company is making profits it can either reinvest in the business to grow it - R&D or starting a new product line for instance - or it can hand money back to the shareholders in the form of a dividend. Or it can buy its own shares so that the amount of shares goes down and the value of the remaining shares goes up. Share buybacks are tax efficient as capital gains tax is normally lower than income tax. They are also very good for the management who are incentivised by share options. They want the value of the shares to go up above all else as that is the way they make real money. The problem is that the long term health of the business - research, rewards for the rest of the workforce, investment of all sorts is neglected when it is taken to extremes - as it is in America.

Almost 60% of the 3,297 publicly quoted non-financial U.S. companies have bought back their shares since 2010. In 2014, spending on buybacks and dividends surpassed those companies’ combined net income for the first time. Share purchases were $520 billion on top of  $365 billion in dividends totalling $885 billion, more than the companies’ combined net income of $847 billion. In other words these companies are investing nothing in the business and, even worse, shelling out considerably more than they are earning. 

To put this in perspective, of the 1900 companies who have bought back their own shares since 2010, buybacks and dividends came to 113% of their capital expenditure compared with 60% in 2000 and 31% in 1990. The gap between what they are earning and what they are paying out via buybacks and dividends has been finances by  issuing bonds - the interest on which is tax deductible.  Despite the obvious fact that too much debt never ends well, the management (who hope to be long gone when that bird comes home to roost) have every personal incentive to ignore the long term health of the company with which they are entrusted.

How bad this has got is shown by the fact director's share sales have hit a four year high  this month, averaging $450 million a day. In other words directors are spending record amounts of money buying back shares  for their corporate treasury—using “other people’s money” to boost the value of their own share optionswhile taking chips off the table by selling their own shares.  

When Michael Lewis wrote The Big Short he painted a picture of the very richest and most powerful people in the world going out of their way to pillage and ruin the poorest and most vulnerable in their own country for their own ends. Legally. It was a picture of financial capitalism, note please, the 'financial' bit, gone disgracefully amok. 

If one imagined that lessons had been learnt from the disasters of 2008 or that corporate excesses and greed had been corralled or tempered you need to think again.There is nothing wrong with capitalism as the least worst way for the world to work economically. But there  is plenty wrong with financial capitalism - and the corruption at the heart of American politics means that its excesses are not going to be addressed by politicians anytime soon. 

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