The Market Ticker
Commentary on The Capital Markets- Category [Market Musings]

There was one lesson today from the FOMC decision.

The Fed downgraded their economic forecast.  The market, in response, shot up 50 handles on the S&P and four hundred DOW points from where it was before the announcement.

What this tells you is, quite simply, this:

ALL of the market's upward move is a consequence of uneconomic decisions made by firms.

It is not due to growth.

It is not due to organic profits.

It is not due to an improving economy.

It IS due to borrowing to buy back stock and other leveraging games, all of which are Ponzi schemes.

And this will end exactly as it did in 2000 and 2008, Larry Kudlow's chortling notwithstanding.

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This sort of story makes me chuckle.

Share repurchases by the S&P 500 corporations totaled a staggering $2.1 trillion from Q1-2009 through the latest available data, for Q3-2014. Over the same period through Q4-2014, these companies paid dividends of $1.6 trillion. Many investors tend to reinvest dividends in the stock market. The S&P 500 has been highly correlated with the sum of these two cash flows.

S&P 500 corporations have had an incentive to buy back their shares ever since 2004, when corporate bond yields consistently fell below the forward earnings yield of the composite.

In other words companies haven't been buying back stock with cash, they've been doing it by borrowing money.

That sounds ok when the corporate bond yield cost is below the forward earnings yield but that's a chimera because borrowed money has to be either repaid or rolled over and when used for a buyback there is no productivity increase that comes from the borrowing.

When you borrow money to build a new plant provided that plant produces enough free cash flow to both service and retire the debt before it comes due the net impact is often positive.  You grow the business and the hit to operating margins occasioned by the interest and principal is temporary; when the bond matures and is paid off (or if you are able to call it early) you retain the forward cash flow from operating the new plant in its entirety.

But when you buy back stock the only change is a temporary increase in EPS, provided everything else stays the same.  That EPS increase, however, is diluted by the carrying cost (interest) and when the principal is due you are exposed to either the requirement to pay the principal or roll the bond, and you have no control over the rollover rate and whether it will be "reasonable" in your view at that time.

When you "take advantage" of machined interest rates that have been forced downward so the government can deficit spend willy-nilly you are, as an executive, betting that this situation will never end.  But such is impossible, as is infinite exponential growth.  Neither can continue forever, and nobody can determine with any sort of certainty exactly when those conditions will reverse.

When it does all of that "excess" EPS, and thus your "excess" share price, will all come back out -- and more.

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This is a rather amusing tape.

As I write this the Dow is down 280, the S&P off 30 handles and the Nasdaq 54.

But -- and this is important -- the U/D volume is not all that wide, and the TRIN for the NYSE is actually under 1.0 with the Nasdaq TRIN just over 1 at 1.04.

This is not congruent with a big decline.

The 10 year yield, on the other hand, is up 6% -- that's big.  The 5-year bond yield is up 7.8%, which is an extraordinarily-violent move.

What to make of all that?  This certainly isn't a decline to short into (it was a good one to short right up front!) but there's also no indication of panic -- which means it's damn dangerous to try to buy it too.

Were I inclined to do something here (I'm not) I'd sit and wait.... and see who got in trouble, particularly in the highly-levered world where some bond and currency traders like to live.

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