
Beware the ‘Buyback Economy’ - LarryDarrell
https://www.washingtonpost.com/business/economy/beware-the-mother-of-all-credit-bubbles/2018/06/08/940f467c-69af-11e8-9e38-24e693b38637_story.html
======
burlesona
Apple - and much of the hugely profitable tech sector - is probably a bad
example to pick on. It’s worth noting, though, that the corporate leverage the
author is concerned about is widespread among all business sectors.

Personally I worry a bit that we’ve run into a sort of soft ceiling on the
economy where the biggest moneymakers are causing creative destruction via
software (Intuit to Accountants, Uber to Cab Drivers, etc) but that we aren’t
seeing the kind of widespread real economic growth (ie productivity gains)
with these shifts that historically accompanied waves of industrialization.
The pie isn’t growing as much as certain players are finding ways to expand
their slices of it at the expense of others.

Perhaps the above is true, perhaps not, I don’t know. But it seems to me that
the entire system we have is predicated on steady macroeconomic “growth” to
function. In one way or another we all depend on the stock market to climb
about 10% a year so we can retire some day and have savings to live off of,
etc. And when that growth isn’t happening via the old mechanism of expanding
industry with solid jobs and wage growth, then Wall Street and the White House
resort to tricks (new financing mechanisms, tax cuts, spending, etc) to keep
the machine running.

The sense I get is that since about 2000 we’ve just been playing different
games to try and get the old mojo back, and that the nature of such games is
to work for a bit and then collapse due to unsustainability. Maybe that’s just
my tinfoil hat coming out, I hope I’m wrong.

~~~
ArekDymalski
>we all depend on the stock market to climb about 10% a year

Can anyone point me to any scientific reasoning behind this? As I'm not an
economist, I was always baffled by an expectation that the market will always
grow. That instantly brings to my mind the comparison to cancer.

~~~
jonknee
It's a byproduct of having more people and more productivity every year, you
don't need large amounts of either for it to compound.

(And you don't need 10%, a lot more money is in bonds than equities and at
much lower rates.)

~~~
thrav
Surely there has to be a ceiling to “more people” though, right?

~~~
jonknee
Yes and that will bring all sorts of troubles, look at Japan for a modern
example. One of many reasons we should be welcoming immigrants instead of
shutting them out.

~~~
hiram112
Yes it'd be a shame if, in the long run, Japan stabilized its population
growth or even shrank down to what was sustainable for several thousand years.

Japan is the size of California, and its population is 127 million or more
than 3x that of CA. The average size of a single family dwelling is less than
half that of the US. Japan cannot feed itself, nor power itself, and depends
on open trade and foreign countries for almost all its natural resources.

This was not always the case, though. Their growth outgrew their borders in
the early 21st century - they were forced to _expand_ into their neighbors'
yards for space and resources, and we all know how well that turned out.

Maybe the idea of endless exponential population growth isn't the best idea,
and if Japan would prefer to keep their culture instead of bowing down to the
globalist elites who want open borders, never-ending GDP growth and markets, I
give them credit.

What we are doing in the West with unlimited immigration and forced diversity
will not end well, IMO.

~~~
jonknee
> Yes it'd be a shame if, in the long run, Japan stabilized, or even
> decreased, its population growth.

Japan's population is currently declining...

[https://www.washingtonpost.com/news/worldviews/wp/2016/02/26...](https://www.washingtonpost.com/news/worldviews/wp/2016/02/26/its-
official-japans-population-is-drastically-shrinking/)

------
jonknee
I think this is much ado about nothing. Companies get killed for cutting
dividends, so doing buybacks are a good way to create value for shareholders
in a manner than can be ramped up and down. It's also more tax efficient (I
pay taxes on dividends, but don't pay taxes on owning an ever so slightly
larger piece of the company).

The author picks on Apple, but doesn't mention that Apple has dramatically
increased its headcount and R&D spending all the while buying back stock. The
truth is Apple is a mature company that is an _incredible_ money making
machine, they literally don't have ways to use the profits to make more
successful tech products. What else should they do other than reward
shareholders?

Anyway, if it turns out when I sell my shares they were bought by the company,
guess what I'll do with the proceeds? Either spend it (stimulating the
economy) or plow it back into other investments. Buyback money doesn't
magically disappear, it just cycles what the capital is being used for.

~~~
aczerepinski
Buybacks often don't creat value for shareholders though. When a stock is
trading for more than its intrinsic value, buybacks destroy value.

Buffett/Berkshire is literally the only example I can think of where they only
buyback shares when prices drop below a certain threshold. Most companies do
it regardless of whether it is creating or destroying value, based only on
whether they have cash authorized to spend.

~~~
jonknee
Who's to say what the intrinsic value is though? If you have an opinion on
that you should be trading on it until the value comes in line and at that
point buybacks are fine.

Buybacks tend to happen at the worst times (boom years) and cut out in
recessions which is counter to what you'd want as an investor. Though if you
think of it more as an alternative to special dividends it makes more sense.

~~~
tptacek
They aren't saying there's a clearly readable intrinsic value for any given
company, only that there is _some_ intrinsic value, and that prices can float
both below _and above_ it. When they do, buybacks destroy value. Obviously,
management will always have some argument to support the higher value implied
by a buyback (it could hardly be otherwise, unless you think management could
with a straight face argue that they should overpay for their own stock). When
they guess wrong --- and they're clearly incentivized to guess high --- they
cause problems.

~~~
skybrian
The thing is, if management is wrong about the price, aren't the shareholders
wrong too?

It doesn't make sense for shareholders to own stock that they think will go
down. If they really think that, they should sell. So shareholders should
think the stock is either fairly valued or undervalued, almost by definition.

Any shareholders who don't sell during a buyback are compensated by owning a
larger share of the company at what should be considered a fair or generous
price from their point of view.

The place where this breaks down is when you believe a company would have a
higher intrinsic value, _provided_ that it has sufficient financing. But this
isn't based on the stock price; it's based on your theory of how much money
you think the company will need.

Also, from a non-shareholder's point of view (say, bondholders), a buyback
means the company's ownership changed, it has less cash, and they didn't get
anything for it.

------
tedsanders
My thoughts on the content of the article:

(1) According to Ray Dalio's theory of long-term credit cycles, we should be
healthiest in the decade after a credit crunch.

(2) When the article says that Apple could use its $210B to buy the bottom 480
companies of the S&P 500, it means any _one_ of the bottom 480 companies. As
worded, that sentence is ambiguous at best and deceptive at worst.

(3) I don't understand the author's point that companies with the most
buybacks saw their value go down the most. Like, isn't that exactly what you
would expect? If Apples gives $210B to shareholders, now Apple is worth $210B
less.

(4) No evidence is given for the claim that all of these companies intended to
use their buybacks to prop up their stock price. I doubt any evidence exists.
Quite possibly, crummy companies like Sears are buying back stock because
returning money to shareholders is better than building new Sears stores.

(5) Does it really matter that much if claims on companies' future profits are
shifting from risky equity to risky bonds? I honestly don't know.

(6) The article argues that the rise of bond ETFs over the past decade ($15B
to $300B, 20x) shows the rise of bonds. But, honestly, most of that comes from
the rise of ETFs, not the rise of bonds. Over the same time period, the total
ETF market, which is mostly equities, grew from $700B in 2008 to $4,600B in
2017.

(7) A lot these 'one decade ago' statistics are hard to interpret, since one
of the endpoints was in the middle of a terrible financial crisis.

(8) The numbers on household credit card debt seem very tragic. I wish I
understood more how people use credit cards.

~~~
jnbiche
> I wish I understood more how people use credit cards.

I'll give you the low-down: many Americans don't make enough money to save up
money for medical emergencies, and other emergencies, so when one of those
happens, they reach for their credit card. Yes, it's a bad idea, but when
they're a few months out of the hospital, possibly still sick, then it's easy
to panic when getting repeated calls from debt collectors and pull out their
credit cards.

Same thing happens with auto repairs and house repairs. And many such
incidental expenses. As a software developer making over $100,000/year, the
instinct of many people here on HN is to say, "why the hell don't they save
more?". But when you're making $30,000/year and raising a couple of kids, it's
really not possible to save money in most cities and their suburbs. Sure, they
could save up more money with that income in a cheap rural area or small town,
but then there's no jobs.

Saving up enough money for medical and other emergencies is much harder to do
for the average lower- to lower-middle class American that many people on HN
might realize.

------
methodover
> least a third of the shares are being repurchased with borrowed money

What?!

That is insane. Right? Like I know I’m just a lowly programmer who doesn’t
know jack all about finance, but I thought the whole point of a buy back was
that your public company was flush with cash and instead of spending it on
capital expenses (am I using that word right? I mean things that grow the
business, like say, Facebook buying Instagram) you spent it on buying stock
from shareholders.

What the heck is the point of a buy back purchase with debt?! I really don’t
understand.

If the article explains it and I missed it, it would be awesome to have it
pointed out.

~~~
twblalock
Businesses use debt as a tool. It doesn't mean they don't also have revenue
and cash reserves -- it just means they have calculated they will be better
off leveraging debt than spending cash for certain things.

Think about it this way -- if you wanted to buy a car, and you had enough
money in the stock market, you could sell your stocks and pay cash for the
car. Or, you could get a car loan at a pretty low interest rate. Why would you
take the loan? You might take the loan because the money you would make by
leaving your cash in the stock market (and avoiding capital gains taxes
triggered by selling shares) would almost certainly be larger than the
interest you would pay on a car loan. So it might make sense to take the loan
and leave your investments alone.

There are not a lot of personal decisions that turn out like that, but a lot
of business decisions turn out like that.

~~~
polotics
Businesses != Managers != Private equity sharks. Time horizons vary, debts and
buybacks are "in the game"...

------
bb88
Mods, title should reflect the actual title of the piece: "Beware the 'mother
of all credit bubbles.'"

------
ggg9990
Crazy to think that just $210 billion can buy you 480 companies in the S&P
500. China could easily do that.

~~~
tedsanders
It can't. $210 billion can buy you any _one_ of 480 companies in the S&P 500.

Buying all of the S&P 500 would take roughly $24 trillion.

The article's wording on that point was very ambiguous and misleading. I had
the same reaction! :)

~~~
ggg9990
Ah ok. Makes more sense.

------
wfbarks
Household debt is not at record highs... Auto Loans and Student Loans are
getting more problematic, but no reason to go all chicken little.

Tend to agree generally that we are approaching the apex of the cycle, and
that share buybacks may be creating a sort of short term thermal.

~~~
vivafrance
> Household debt is not at record highs

Ummm, yes it is: [https://www.cnbc.com/2018/02/13/total-us-household-debt-
soar...](https://www.cnbc.com/2018/02/13/total-us-household-debt-soars-to-
record-above-13-trillion.html)

~~~
wfbarks
Meh... You have your facts and I have mine...
[https://fred.stlouisfed.org/series/TDSP](https://fred.stlouisfed.org/series/TDSP)
and
[https://fred.stlouisfed.org/series/HDTGPDUSQ163N](https://fred.stlouisfed.org/series/HDTGPDUSQ163N)

~~~
vivafrance
Your facts are measuring something different. The first measures the service
payments. The second measures debt to gdp. Talk about moving the goal post.

------
mathattack
When companies cease to have productive things to do with money, it’s time to
return it to shareholders who can invest it elsewhere. In principle this is
the natural way of the word.

This is complicated by tax laws which allow companies to write off debt. This
helps create lower risk debt capital but increases the risk of the remaining
equity. Not the end of the world. Just invest in both.

I’m somewhat concerned by companies borrowing too much and dying, but creative
destruction helps new entrants.

------
acover
How do bond ETFs work?

I thought with stock ETFs they were convertible when you had a large number.
This would keep the etf price in line with it's underlying assets.

The issue with bond ETFs is I don't think the underlying bond is exchange
traded. How would the conversion work?

I ask because this article has reminded me that I should probably diversify
away from bond ETFs into GICs

~~~
mabbo
My understanding is that there are markets where bonds can be bought and sold.
An ETF of bonds is just a large fund holding a set of bonds and trying to keep
track of their current value.

Since you know what the return on the bond is, at what price, interest rate
and time, you can very easily assess the current value of a bond, especially
compared to what you might make if you just bought GICs at the current rate.
An interest rate hike today lowers the sell price of bonds purchased at
yesterday's rate.

~~~
acover
I think the market is still brokers talking. There is no centralized exchange.

[https://www.quora.com/Why-isn’t-there-a-bond-exchange-
equiva...](https://www.quora.com/Why-isn’t-there-a-bond-exchange-equivalent-
to-the-NYSE)

------
useful
Weren't loans taken out as a way to avoid taxes pre-2018? You could have
profits stored offshore tax-free and take a loan out in the US that generated
money for your US operation without incurring taxes. These loans are very low
interest rates and companies still don't have incentives to pay them off.

------
test6554
When you know you are near the edge of another economic cycle, why not focus
in short-term decisions? Large capital expenditures just before a recession
doesn’t really make much sense. Better to board up the windows than expand in
this context.

------
rectang
Since buybacks increase concentration of ownership, do they tend to combat the
short-termism of uninvolved, absentee shareholders? Or is there no consistent
pattern?

------
fierro
Can someone give a concise ELI5 summary of this? I lack some of the context
tomfukly understand this article

------
aurelien
Sound like this website make so much pornshit on your privacy that GRPD does
not let you access to it. It should be a fucking communist stuff that spy
american pure people.

------
baybal2
Stupid move - tax cut was a perfect moment to reduce your debts. These guys
did the opposite

~~~
bokstavkjeks
Debt can be a strategic tool for a company. They want to maintain a certain
debt-to-equity ratio as eliminating debt would probably be more expensive in
the long run than maintaining that ratio. The ratio is, of course, not set in
stone and is rather industry specific. The short, sweet, and overly simplified
version is that debt provides tax shields and liquidity now. $100 now can be
worth more than $120 in five years, so most companies are okay with a certain
amount of debt.

~~~
baybal2
But not now. Find a major company that is not critically overleveraged thanks
to near net negative interest rates few years ago. Now there is a chance that
effective rates will go all the way to eighties era numbers next decade, and
the next debt crisis may also be close.

