Most market participants are completely unaware of the dangers of stock buy back programs, which have been all the rage since around 2011 and the injection of Fed Liquidity into the markets. Stock buy backs have no tangible benefit to corporations. They are a wash for investors, and greatly increase corporate risk.
Rarely have corporations ever utilized Buy Back programs at the optimal point – when stock prices are low. They usually buy at the top, and the entire rally in the market since around 2011 has basically been fueled by easy money and stock buy back programs.
A VERY brief history;
After the Stock Market Crash of 1929, the SEC put rules in place to stop the very things that had caused the crash, which were stock market manipulation by corporations and trading firms fueled by extreme leverage.
In 1982, SEC rule 10b-18 cleared the way for Stock Buy Back Programs to start. Prior to 1982, Stock Buy Backs were considered to be market manipulation of your stock price, which they actually are (more on that in a second). Rule 10b-18 basically stated that Market Manipulation of your stock price was still illegal, in every way except for Stock Buyback programs, which are actually the biggest market manipulation of all. THANKS SEC!
The Era of the Stock Buyback (AKA the Unending Market Pump) 2010-Present
As most of you are probably aware, many were still quite bearish on markets in 2009 and 2010. These funds and individual traders were trying to fairly determine stock prices based on traditional metrics like earnings, future earnings, EPS and similar.
Enter the unending stock market Pump (AKA Stonks Only Go Up)
You might be asking why buy back programs only started gaining popularity in the 2000’s rather than when rule 10b-18 first cleared the runway back in the early 80’s. The answer is twofold.
- Access to easy money at very low interest rates. Interest rates in the 80’s and 90’s were very high compared to what they have been over the last 20 years. Corporations didn’t want to borrow money at high interest rates to effectively buy back stock when they understood the long-term impact of such programs were negligible and there were no incentives to do so
- Entrance of corporate officer incentive programs, where short term company metrics are rewarded with huge bonuses and incentives
The Buy Back Shell Game
Corporations borrow money at extremely low interest rates, take it to the stock market, and pour money into their own shares, fueling higher and higher prices.
Everything looks great to investors on the quarterly reports, and Chief Officers are lavished with huge incentives and Bonus checks
Corporations who just bought back shares inflating their stock prices, do ‘stock offerings’ to raise even more cash. Yes, stock offerings often cause share prices to dip, but not nearly enough to offset the endless loop of Market Buy Backs and Stock price manipulation. As an added benefit to corporate officers, these Executives often include the shares they have been given by the corporations as Bonuses in the Stock offerings as well. Yeah! FREE Money!
The Shell Game continues as CFO’s are able to easily manipulate standard metrics such as EPS in their Quarterly Earnings Reports to ‘massage’ the numbers making them look much better than they actually would have. In other words, an ESP of $1.00/share last quarter may actually be much MUCH better than an EPS of $1.50 THIS quarter thanks to the Buy Back program manipulation. Everything looks great to the market and investors though!
Buy back programs are straight up stock manipulation. They inflate prices, and the ‘Market’ doesn’t become aware of what has actually happened until many months later when these often very difficult to detect Stock Buybacks are buried and hidden deep within the corporate 10k reports.
The market has no idea stock prices are being supported on a daily basis due to corporate Buy Backs on the open market, so this manipulation can’t be fairly factored into current prices. To the Market, it just appears as though there is unending demand for the company’s shares. It’s not required to announce you are buying back shares as you are doing it. Prudent Investors are only made aware of such programs at a much later date.
Stock Buybacks at inflated stock prices look great to the market when prices keep increasing and there is endless ‘free’ money to continue the manipulation.
But what happens when stock prices start tanking, and there is no more ‘free and easy’ money to continue these buyback programs?
This is the risk part of the equation. Remember when I said earlier that corporations don’t usually participate in buy back programs when prices are low? That’s exactly what is happening right now. Here is an article from Oct of last year talking about the ending of buyback programs. Every day we hear about another corporation who won’t be participating in these programs in the near term future.
So what does all this mean?
A major source of market liquidity has dried up. Corporations are hoarding cash right now to shore up for the uncertain times ahead.
Inflated and manipulated stock prices due to these buy back programs are in huge danger of collapsing with very few true buyers left, besides the Fed.
We could see upcoming earnings reports start showing more ‘truth’ about what is actually going on with actual corporate earnings instead of the easy manipulation that’s been going on for years.
No one can really know for certain what the true levels of corporate earnings are going to look like
a. without all of the manipulation of the buyback programs occurring
b. with real earnings growth and guidance being hindered worldwide due to the pandemic
Everyone has a pretty good idea that forward earnings are going to be bad, for Q2 at least. Remember, upcoming earnings are still going to be Q1, so many will probably still be decent, since the market has basically given a green light to the fact it’s OK not to give forward guidance.
The massive issue is that when the inevitable sell-off starts again, either because of unexpectedly large earnings fails or unexpectedly bad forward guidance, it’s going to be a fucking shit show.
Who the fuck knows what the actual ‘free market’ will value corporate stocks at when left to it’s own devices. There has been no free market in asset prices for 10 years because of Fed liquidity, easy money, and corporate Buybacks.
Yes, the Fed can and will step in to the best of their ability to keep propping up markets. They can’t do it forever. Not only that, but it’s impossible for them to be stepping in and propping up shares of every corporation in the US that has been participating in these buy back manipulations of the last 10 years.
TL;DR – No, THIS ISN’T JUST A “HEALTH” CRISIS Mr. PRESIDENT. It’s a full-blown fucking asset price crisis that is unfolding, contrary to what you’re being told.
Get ready for Q2 earnings, and potentially earnings for the next 4-6 quarters to be much MUCH worse than expected due to limited ability to manipulate EPS in the 10-k reports
Also, expect selloffs to come in hard and heavy with the lack of corporations participating in share buy back programs any longer