The Bubble Of The Sociopaths

…Or the brightness in the memory of the failed hotel
where the waiters in their immaculate white uniforms
were barefoot…

—Gilbert

Spring of 2000 looked for all the world to me like the popping of a huge stock market bubble, an overdue event that had been building for decades. The market was as frothy as I had ever seen it. Little old ladies were cashing in government bonds to buy dot coms, frantically snatching up new issues with zero fundamentals and virtually no chance of successfully carrying out their bizarre business plans.

Big Bust ahead

It was a top of sorts. But before a real washout-something to be expected when too many fools drive valuations beyond reason-the Fed stepped in and halted the collapse by drastically lowering  interest rates. This came to be known as the Greenspan Put, meaning “Don’t worry folks, I’ll print money so you won’t have to take your medicine for being foolish.”

With cheap money, the party migrated to real estate. When that bubble popped, it looked, finally, as if a thorough cleaning of the Augean Stables was underway. Another chance missed. Instead, the Fed bailed out the banks and furiously printed money to get the economy back on track. The recovery has been tepid, although government reports fancifully say things are fine.

So now, completely ignoring a crappy economy, the stock market starts up again and steadily cruises to an all time excess of valuation and sentiment, and I’m up nights, trying to figure out what’s left to inflate, and how.

I am slow on the uptake. It was right in front of me. With ZIRP, the Fed’s Zero Interest Rate Policy, meaning absurdly low rates, corporations overcame their lousy earnings by borrowing money to do stock buybacks, shrinking the number of shares outstanding in order for flat to lower per share earnings to be higher when divided by fewer shares outstanding. Does this make sense? Of course not, unless you’re a CEO whose bonus is tied to the performance of the stock. You load the company with debt so you can shrink the equity. Your huge, reckless buy orders drive the stock up. Now you can exercise your stock options profitably.

Here’s a typical example: Caterpillar’s revenues have gone nowhere for several years

Caterpillar sales

But the stock has held up:

Caterpillar stock

The company has consistently beat analysts’ earning estimates by spending huge amounts of money doing buybacks to shrink the shares outstanding.

CAT buybacks

Note that capex (capital spending for growth) is in the toilet. Obviously, management doesn’t see business growth on the horizon, so they can make things look good by shifting paper around. Who wins? Short term, the management. Long term, the shareholder is holding the bag when leveraging the balance sheet in front of an obviously deteriorating economy becomes unsustainable.

Is this a popular strategy?

From Zero Hedge:

…as we showed yesterday, in Q1 companies in the S&P 500 spent a record amount of cash not on growth (or maintenance) capex, not on employee salaries, but on stock repurchases – that one most direct way to boost a company’s stock price and to “beat” Wall Street expectations by reducing the number of shares outstanding.

And now we also learn of the other “unintended” benefit of record stock buybacks, if only to CEOs: as a result of cost-indiscriminate buying back of their stock, as in using corporate cash, Corporate CEOs, whose pay is now more closely tied to stock performance than ever, were also paid the most. Ever.

Or to simplify further: out of the corporate cash pocket and into the personal cash pocket. Rinse. Repeat.

And since the S&P 500 ends up at record highs, everyone is happy, except for the employees of said company, who, long after the CEO is retired on their own private island, are virtually assured of wholesale layoffs as the next management team scramble to figure out how to keep the business going under a record debt load…

So, it’s a bubble, not driven by the mindless over enthusiasm of speculators. The three trillion dollars corporations have flung into the market since 2005 constitute a calculated move by sociopath CEOs to enrich themselves. If they get out before they’re found out, they will make out. The result will still be a crash. And, by adding significantly to the economy’s total debt, the next downturn stands to be the mother of all downturns. Ain’t that grand?

Cheers,

Rod

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