MorningWord 6/3/15: The Train Keeps Rolling, Until it Doesn’t

by Dan June 3, 2015 9:35 am • Commentary

The result of socializing losses from the global financial crisis starting eight years ago, and the subsequent crisis monetary policy has caused the largest transfer in wealth to the private sector the world has ever seen.  I am not sure this is the way this all supposed to go down, but it’s pretty clear that central bankers and politicians have been making this up as they go, with little thought about how to end these policies and even less control over the myriad of unintended consequences.  One thing is certain, the world was spared a global depression and crisis policies played a huge role, but the rolling QE / ZIRP policies of central banks eight years after suggests that the crisis may in fact be perpetual.

As for the unintended consequences of free money for perpetuity, investment rationales start to get silly.  Yesterday in this space (The Surge to Merge) we touched on the propensity for public companies to return capital to shareholders in the form of special / regular dividends and share repurchases which has been followed up by an explosion in M&A activity of late.  Last month’s activity reached a fever pitch, representing the single largest total ever. Per

The overall value of deals in US-bound mergers and acquisitions activity amounted to $243bn in May compared to $226bn during the same month in 2007 and $213bn in January 2000, the previous biggest and second biggest months respectively, according to Dealogic data.

Per Bloomberg:

Mergers and acquisitions totaling $1.4 trillion have been announced and completed this year. That puts 2015 on a pace to trail only the $3.4 trillion of 2007.

On Monday, Josh Brown on his blog The Reformed Broker put this sequence of corporate action in some sort of historical context and the prevailing investor psychology:

The M&A boom just gives us one more reason. “If I sell now, chances are the buyer of my shares is either the CFO of the company executing a buyback or an activist who is about to push the stock into a buyer’s embrace.”

There’s a very 2006-2007ish quality to the desperation to participate. For those of you who weren’t there – the gist of every investment thesis was that such-and-such company is a no-brainer candidate for an LBO and that even if the stock went down, the value of the real estate on the company’s books would more than make up for it.

Substitute M&A / Buybacks today for LBOs and Private Equity 8 years ago and the rationales are largely the same.

I have made the similar point on the substitution part on many occasions, and I think Josh would agree that it nearly impossible to pinpoint when the jig will be up. I suspect that much like 2007/2008 the first signs will be the inability for acquirers to get deals done, but we are far from there yet.

I would add one more point, Bloomberg had an interesting story this morning, Borrowing Spree by Healthiest U.S. Companies Sows Leverage Worry:

As recently as last year, companies in the Standard & Poor’s 500 Index had the lowest net-debt-to-earnings ratio in at least 24 years. Examining a slightly different universe — companies, excluding financial firms, with top credit ratings who’ve issued debt — the median net leverage in the first quarter of 1.267 was the highest since 2010 and up from 0.927 in the first quarter of 2014. The leverage figure means companies owe $1.267 for every dollar of earnings after subtracting cash on hand.


Investment-grade non-financial companies spent $805 billion on buybacks and dividends last year — a record high and only slightly less than what they earned during the year, Morgan Stanley strategists led by Sivan Mahadevan wrote in a May 29 note.

Companies in the S&P 500 will dole out more than $1 trillion, or two-thirds of their cash, buying back stocks and repaying dividends this year, according to Goldman Sachs Group Inc. That eclipses the $921 billion the firms will spend running their businesses and on research and development, Goldman Sachs wrote.

Borrowing to fund shareholder-friendly transactions suggests, among other things, that companies doubt their ability to grow by traditional means, according to the Morgan Stanley strategists. The record purchases have also drained cash reserves, meaning “corporate balance sheets are no longer as pristine as they were in the immediate aftermath of the financial crisis,”


The buyback boom is an “economic distortion” caused by the Fed’s near-zero interest rates, said Rick Rieder, chief investment officer of fixed income and fundamental portfolios at BlackRock Inc.  There is nothing wrong with stock buybacks and dividends per se, and indeed they can contribute to a very sensible corporate capital allocation strategy,” Rieder wrote in a June 1 web post. “But should this use of capital crowd out long-term capital expenditure (investment) in a firm’s core business, or begin to threaten its credit quality, then it can become concerning.”

So some fairly smart financial minds are starting to get a bit worried about those unintended consequences of the Fed’s QE and ZIRP, but the train keeps rolling, until it doesn’t. And while equity valuations are a far cry from bubbles past, I think it is important to note that there are plenty of other risk assets that have been fairly crashy of late, and the extreme volatility in currencies, U.S. and European Treasuries, and of course commodities is likely to foretell a greater level of equity volatility in the not too distant future.