What Can't Go On Won't Go On, Part 1: Corporate Leverage
By now everyone knows the corporate share repurchase story, about how major companies are engineering higher per-share profits and share prices by buying back their stock and raising their dividends. But just how much they're spending may still come as a shock.
Today's New York Times quotes Laurence Fink, CEO of mutual fund giant of BlackRock, bemoaning the short-sighted behavior of his peers: "Mr. Fink noted that companies in the Standard & Poor's 100-stock index are paying out 108 percent of their earnings to shareholders."
That's a lot of cash flowing out the door, and leads to the obvious question of where the excess is coming from. This morning Bloomberg provided the answer, via a chart from Citigroup analyst Stephen Antczak, which is of course that they're borrowing it:
Gross corporate leverage for both investment-grade and junk borrowers is at record levels, and defaults are, not surprisingly, now projected to start rising. The implication: borrowing terms are going to become a lot less favorable, staring with low-quality names and then moving up the ladder to the Blue Chips doing most of the repurchasing. Says Citi:
"The robbing Peter to pay Paul dynamic that has dominated the investment landscape in recent years may be coming to an end as the credit cycle begins to turn and a meaningful pickup looms in the corporate default rate.
Recent conversations that we've had with equity [portfolio managers] suggest that they have become far more focused on revenue growth, and are placing far less of a premium on any financially engineered EPS growth. The fact that a basket of stocks that [has] been reducing shares outstanding is meaningfully underperforming the S&P 500 on a beta-adjusted basis suggests that this view may not be that of just the investors we talk to, but far more broadbased.
Now the question becomes what, if anything, takes up the slack when corporations stop buying back their shares. One candidate is an inflow of foreign capital fleeing the even bigger messes now being made in China and Europe. But barring that, US share prices will have lost a huge source of support.