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This One Trick Is Propping Up the Stock Market—What Happens Once It's Gone? Lombardi Letter 2018-11-16 07:16:51 Companies have become financial engineers. They could be boosting the stock market with buybacks and dividends. This could have dire consequences down the road. Here’s why. Stock Market https://www.lombardiletter.com/wp-content/uploads/2018/11/The-Stock-Market-Could-Be-Financially-Engineered-Higher-150x150.jpg

This One Trick Is Propping Up the Stock Market—What Happens Once It’s Gone?

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The Stock Market Could Be Financially Engineered Higher

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The Stock Market Could Be Financially Engineered Higher…

Companies on the stock market have become financial engineers. This is boosting their stock prices and earnings. It’s scary. This could have dire consequences down the road.

Before going into any details, let us give you some statistics on what’s really happening…

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It looks like the stock market is being propped higher by the companies themselves rather than investors.

Consider that in the second quarter of 2018, companies on the S&P 500 purchased $190.62 billion worth of their own shares. In the same quarter of 2017, S&P 500 companies bought back $120.11 billion of their own shares. (Source: “S&P 500 Stock Buybacks,” S&P Dow Jones Indices, last accessed November 15, 2018.)

Simple math here: year-over-year, buybacks soared by over 58%.

In the trailing 12 months, they have purchased $645.81 billion worth of their shares. In the same period a year ago, this amount was $500.75 billion.

Digging deeper into the details…

Between the first quarter of 2013 and the second quarter of 2018, S&P 500 companies have purchased $3.03 trillion worth of their shares.

Don’t for a second think this is just a thing with S&P 500 companies. This phenomenon prevails across the stock market.

For example, look at Spotify Technology SA (NYSE:SPOT). It’s not a part of the S&P 500.

This company just debuted on the stock market earlier in 2018. Recently, it announced $1.0 billion worth of stock buybacks! (Source: “Spotify plans to buy back up to $1 billion in stock,” TechCrunch, November 5, 2018.)

Why Is This Worrisome?

Understand that at times, buybacks may be good. But if you see them staggeringly high over time, it’s worrisome. Over the past few years, we have seen this.

Companies on the stock market are using their earnings and spending it on buybacks and dividends. Between the first quarter of 2013 and the second quarter of 2018, S&P 500 companies had operating earnings of $5.47 trillion. The total dividend and buyback amount in this period was $5.11 trillion.

So, over 93% of their operating earnings were used to buy back stocks and pay dividends to shareholders.

All this money going into buybacks and dividends doesn’t really do much other than reduce the number of outstanding shares, inflate earnings, and bring the stock price up. $3.03 trillion by S&P 500 companies alone is a massive figure. If this money went into new projects, it could have made a massive impact on the U.S. economy.

Here’s one more thing: When companies buy back their shares at a record amount, they are essentially saying that they don’t see any other opportunity out there. It shows pessimism.

Lastly, one has to question what will happen once corporations are forced to put the brakes on their stock buybacks. Understand that interest rates are moving higher. Low interest rates gave incentives to companies to buy back stocks. Will the stock market be able to sustain itself when companies aren’t there to buy? It’s really hard to think that this will be the case.

As I said earlier, companies are financially engineering the stock market. This may sound a little edgy, but I will say it: This is kind of like manipulation. I also know that manipulation can go on for a while, but not forever. When buybacks stop, stock markets could severely drop.

Editor’s Note: Hi, Moe Zulfiqar here. If you enjoyed this article, you can get more of my opinions and commentaries in our popular newsletter, Lombardi Letter. Published daily, it’s FREE! Join us when you click here now.

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