Posted on: Monday, July 21, 2014
Written By:"The Elemental Economist" Jim Purnell
Dollarcollapse.com report by John Rubino on July 9, 2014 [ For the average person trying to decide how to feel about the economy, the single biggest data point is the stock market. When share prices are rising, the implicit message is that finance professionals — who, after all, dedicate their lives to understanding such things and should therefore know what’s happening — have decided that life is good and getting better.
So the rest of us relax and go shopping. Known as the “wealth effect,” this tendency of asset prices to affect consumer behavior is now a key policy goal of the US and pretty much every other major government.
But what if it’s all a gigantic, multi-trillion-dollar con? That’s the conclusion a growing number of analysts are reaching as they dig into the reality behind the recent record highs in US equity prices.
The first part of the story goes like this: The US has lowered interest rates to the point where it is actually more profitable for many companies to borrow money and use the proceeds to buy back their own shares, thus eliminating the need to pay dividends on those shares. Gordon T. Long of Macro Analytics recently ran the numbers:
What do corporate CEOs and Boards know which everyone is missing and that is driving them to executing corporate buybacks approximating $2 Trillion over 24 months? The answer is a free tax ride thanks to the Macroprudential Strategy of the Fed’s ongoing game of Financial Repression. A game which may be quickly getting out of control!
UNPRECEDENTED BUYBACKS LEVELS
In case you are in the 1% who have been too busy counting your startling increase in net worth, let me first highlight the velocity with which corporate buybacks have accelerated to.
90% of all S&P 500 profits are presently being spent on corporate Buybacks and Dividends. This is historically unheard of. We are approaching nearly $2 Trillion in buybacks by the S&P 500 members within a forecasted 2 year period. So why is this distortion happening?
A FREE TAX RIDE
We presently have one of the biggest tax ruses in history going on as the Fed and US Treasury desperately try and increase the wealth effect to elevate asset prices and finance government debt. To make low bond yield seem relatively attractive (at present historic lows), the Fed needs to get stock yields down via elevating stock prices. Corporations have been willing accomplices in this charade.
GENERIC TAX EXAMPLE
Dividend payout rate approximates the S&P 500 average of 2.25% per annum.
Borrowing costs approximate 3.5% per annum
Corporate nominal US tax rate 35%
Assume stock trades at $100/share with 100 shares outstanding,
Market Capitalization of $10,000 (100 X 100)
A 2.25% Dividend rate means a $2.25 Dividend payout per year.
If we were to borrow $225 to buyback 2 1/4 shares it would cost $7.89 ($225 @ 3.5%)
The tax deductibility of $7.89 at a nominal tax rate of 35% would be $2.76
Therefore our model corporation would save $0.51 ($2.76 – $2.25)) by borrowing to buy back their shares.
Long goes on to illustrate the point using Apple & IBM, and concludes that buying back stock, even at today’s elevated levels, is a profitable arbitrage.
What does this mean? The short answer is that the bull market is fake, fueled primarily by companies looking to save money on taxes rather than invest in undervalued shares. In effect they are, with the government’s help, tricking both their shareholders & individual investors into buying overvalued equities in order to generate bigger year-end executive bonuses for themselves.
Arguing for the validity of this cynical conclusion is the fact that corporate insiders are selling their personal shares while directing their companies to buy back those same shares. See Rise in legal insider selling raises yellow flag:
Corporate insiders are selling shares of their own stock at a quickened pace at the same time the U.S. stock market is making new highs, a bearish sign that raises a yellow caution flag for investors.
Neil Leeson, an ETF strategist at Ned Davis Research, zapped out a warning to clients today about “legal” insider trading.
“Despite the fact that most investors feel they have no alternative to being fully invested (in stocks), there is one crowd of investors who has turned into pretty consistent sellers, and that’s corporate insiders,” Leeson told clients in a video.
In fact, insider selling has picked up so much that is has generated a new “sell signal” on the market, Leeson said, citing an NDR indicator that tracks and measures insider buying and selling.
“Insider selling,” Leeson says, “is typically bearish for markets.”
When insiders are selling, it sends the message that they believe their company’s shares have become fully valued and, therefore, have limited upside.
The second part of the story is even more disturbing, because it involves the world’s central banks which are now, apparently, buying equities directly. From Cris Sheridan at Financial Sense:
Last month, a report released from the Official Monetary and Financial Institutions Forum (OMFIF) gained wide attention by shedding light on yet another powerful force that may contribute to overheating markets around the globe.
In a recently published interview with Financial Sense, David Marsh, Co-Founder and Managing Director of the OMFIF, explains how central banks are now suffering the consequences of their own low-rate policies and, like everyone else, attempting to earn greater returns by shifting directly into stocks.
Although a limited number of central banks have been doing this for quite some time, on a “worldwide scale it is relatively new…and therefore really worth taking heed of,” said David.
When asked how long this might last, David didn’t think this was a temporary move but “part of a longer-term trend.” Central banks, he said, “tend to be rather herd-like creatures. They will look at this market for a number of years, figure out how best to attack it…and then once they’ve discovered a taste for these markets, they will stay there.”
Although careful with his choice of words, David does warn that this growing trend may contribute to a “slightly overheated international equity market”:
“I’m not saying that this is the factor driving the markets but it may be a factor in some areas leading to a possible tendency for overheating. It is interesting that the central bankers’ bank, the Bank for International Settlements, just over the weekend has pointed out that some capital market participants are getting a little bit carried away by euphoria and investing too much in risky assets. And, of course, this is really like the pot calling the kettle black because many of the shareholders of the BIS, which includes 60 central banks from around the world, are themselves investing in equities. Although they are trying to do it, I’m sure, in a way that isn’t driving up equity prices, they may be in aggregate helping to lead to what we might think in future years has become a slightly overheated international equity market.”
The result of all this more-or-less random stock buying is a market that is, by pretty much every valuation measure, hyper-expensive and therefore ready for (at least) a serious correction ]
Does anything else need to be said? Its all a ruse & the price for this insane attempt to circumvent the free market consequences of the economic policies since we disconnected the dollar from its sound money gold backing in 1971 will be massively multiplied beyond our wildest dreams thanks to this house of cards. You see, after printing tens of trillions of fiat (paper) dollars out of thin air & finding that your efforts have failed to manifest the desired outcome you are forced to make emergency preparations in order to escape the collapsing bubble you have therefor created or suffer abject poverty in the aftermath.
This is why we are witnessing the corporate titans, who have been the FEDs cheerleaders during the failed easy money policy efforts, borrowing billions at record low rates in order to permit the selling of their personally owned artificially elevated shares & cover their sales with purchases with said borrowed monies in the companies name so they can escape with their record profits while putting the potentially massive losses around the companies neck. This will permit them to secure millions in ill gotten profits while artificially inflating their companies stock value which in turn sets up the billion dollar ‘golden parachutes’ that will carry them safely to a cushy lifestyle of retirement by the ripe age of 40 after 2 decades of fleecing the general publics wealth on Wall Street. When this takes place the average person will be wondering what happened to everything they saved their entire lives, resulting in panic & social unrest when the reality finally sets in. Adding insult to injury these very corporate snakes will be living a luxurious life on the island they bought for pennies on the dollar when Greece was auctioned off at fire sale prices when this very game was piloted a couple years ago in Europe.
It has never been more important than today to secure your wealth by diversifying out of paper investments & the institutions that control these paper assets, and into hard money assets that will not only stand the test of time but multiply exponentially as they become the desired asset of roughly 8 BILLION people on the planet attempting to escape the collapsing façade that is our 100 year global fractional reserve banking experiment. Gold & silver bullion at minimum will protect our net worth while fending off inflation. At best they will explode in demand thus driving prices upward with its demand as the stability of the global economies become shaky.
Don’t drink the Koolaid of Wall Street any longer, remember they didn’t see the dotcom bubble, didn’t see the housing bubble & surely won’t see this bubble that they are dancing on top of inviting you to gamble the remnants of your life savings from the previous two bubbles on this 1920’s style build up to our next period of wealth destruction. Tick tock.
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