Quote of the Week
“Enthusiasm is more important to mastery than innate ability, because the single most important element in developing an expertise is the willingness to practice.” – Unknown
Stocks finished last week higher, with the S&P 500 rallying 4.4%, the best weekly gain in six months. At the same time, bond yields declined to the lowest levels in two years. This normally doesn’t happen together. When the stock market goes up, bond yields also go up. When the stock market goes down, interest rates usually go down. I think the stock market going up last week is a contra trend rally off the lows of six straight weeks of market declines. I trust what the bond market is saying rather than a short-term rally in the stock market.
Last week the announcement of May job increases came in at a disappointing 75,000. The expectation was somewhere around 150,000 to 175,000 new jobs. This poor jobs report along with the Fed saying they will take into consideration lowering the Fed’s Funds rate (interest rates) in the future if the data indicates. The markets seem to think that the Fed will come to the rescue. Even if the Fed does lower interest rates, it may not help as much as the markets hope. The economy is clearly on a downward path, and the rate of change is accelerating.
The rest of the world is slowing, and the tariffs with China are certainly not helping. One of the problems with the tariffs is that businesses don’t know how to plan for the future, and all the established trade channels have been disrupted. It is looking like the second quarter GDP number will be quite a bit lower than the 3.2% growth for the first quarter. This potentially lower GDP number will rustle the feathers of those who want the Fed to cut rates.
Stock Buybacks: Worst Mistake Ever
A lot is driving this bubble we’ve been in since 2009, but good fundamental trends and things like demographics and technology are not among them. The biggest inflator has been the $13 trillion worth of quantitative easing (QE) courtesy of central banks. Thanks to their significant gift to all but the retail investors like you and me, speculation has been the norm.
With higher cash flow and cheaper borrowing rates, all in a slow-growth economy, companies quickly learned that the best way to increase their earnings per share (EPS) was to shrink the number of shares available.
In 2018, Mr. Trump added the massive tax cuts to the stimulus plan. That created even more direct cash flow to corporations, who responded with record stock buybacks of $806 billion last year, which was a 56% increase over 2017. JP Morgan expects we’ll see about as many buybacks this year. The 2019 number is an estimate. Regardless, it’s insanity.
Take a look at this graph of the history of stock buybacks.
Here is how stock buybacks affect the earnings per share. Let’s assume that a company has 100,000 shares outstanding. Let’s further assume that the corporation earns $100,000. That equates to earnings of $1 per share. Now, assume that the corporation buys back 50,000 shares and the earnings stay at $100,000. If you divide the $100,000 of earnings by the new outstanding shares of 50,000, that equates to $2 of earnings per share. Obviously $2 earnings per share looks a lot better than $1 earnings per share so the stock price goes up if the multiple of earnings stays the same.
What has happened? First, the share price has doubled. Second, all the money used to buy the stock back hasn’t done the economy any good. It hasn’t gone to expand the business, hire more employees, or purchase new equipment. All it has done is increase the share price.
Since 2009, corporations have done more than 90% of net buying in the stock market. As the New York Times accurately describes it, “This stock market rally has everything except individual investors.” Institutional buyers, aka the smarter money, have been net sellers. Individual investors, like you and me, have been neutral, while foreign buyers have been only slightly involved in stock purchases.
Rather, the dizzying gains in the U.S. stock market has enjoyed are a result of $5.6 trillion worth of stock buybacks over the last decade. That’s an average of $500 billion per year. It’s no wonder that some politicians have introduced a bill to ban open-market stock buybacks.
All this while the U.S. GDP between 2007 and 2018 only reached a cumulative 19% gain. That’s lower than GDP growth during the Great Depression, which came in at 20%, cumulatively, between 1929 and 1940.
It all just goes to show that this current market increase (bubble) is built on nothing but baloney.
|Name||Wkly %Chg||YTD %Chg|
|Dow Jones Industrials||+4.71||+11.39|
|10-yr Treasury Yield||-0.05||-0.60|
|*5-day performance ending Friday|
By the Numbers
SIX-TO-ONE RETURN – The average American worker who retires next year (in 2020) will have paid $36,000 in Medicare taxes during his/her working lifetime, far less than the $229,000 in Medicare benefits that he/she is projected to receive. The projected lifetime benefit total is net of Medicare premiums paid by the retiree (source: Urban Institute). Michael A. Higley, BTN 06-10-2019
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These are the opinions of Larry Lof and Stephanie Mayoral and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Past performance is not indicative of future results. Due to our compliance review process, delayed dissemination of this commentary occurs.
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