The Economy And The Stock Market: The Case Of Stock Buy Backs

Includes: DIA, SPY
by: John M. Mason

American companies continue to buy back their own stock in large amounts. The Wall Street Journal reports Wall Street Journal reports that, through September, United States companies bought back $274 billion more is stock than they issued. To me, this information conveys a picture of an economy going nowhere.

Over the past four years I have been observing the corporate build up of cash. And, the cash hordes just grew and grew. Many analysts argued that these corporations could use this cash to pay dividends or to buy back their stock.

A third option, however, mergers or acquisitions, seemed more plausible to me over this time. My argument was that as the economy picked up speed the corporations that were in good financial condition and that had a pile of cash on hand could, basically, cherry-pick off those organizations that were not so strong and thereby become stronger themselves or move into other areas or markets that would enhance their value.

These transactions, I believed, would not spur on economic growth in the short run but would lead to a stronger economy and a more productive corporate base than had existed before the financial crisis. It turned out I was wrong. The economy never really picked up steam, the way most economies do when recovering from a recession, especially one as deep as the one we went through in the 2007 to 2009 period.

Furthermore, the economic policy of the Obama Administration over the past four years created a very uncertain business environment, one where it was difficult to understand what was going to pay off and what wasn't going to pay off. As a consequence, not only did the corporate sector engage in real investment spending, spending on plant, equipment, and other capital expenditures, they did not engage in much merger and acquisition activity.

Frankly, I was quite surprised that an M&A binge did not take place. And, then buy backs started to pick up. And then corporations began increasing dividends or declaring special dividends as concerns over the "fiscal cliff" grew. But, the movement has accelerated since President Obama got re-elected.

Last week, General Electric (NYSE:GE) announced plans to buy back $10 billion of stock over the next three years. Untied Technologies Corp. (NYSE:UTX) said it was going to resume its share repurchase program, buying back up to $1 billion in stock. Boeing Co. (NYSE:BA) stated that it could buy back as much as $2 billion. International Business Machines Corp. (NYSE:IBM) has "one of the biggest share buyback plans" planning to buy back $50 billion of its own stock through 2015.

This behavior, to me, is not consistent with a corporate worldview that is bullish on the near future. It is not behavior that is very confident of the next four years. The Chief Financial Officer of Honeywell International Inc., Dave Anderson, is reported to have described the macroeconomic environment as "challenging and uncertain."

Honeywell has said, "it is replacing just one out of every four workers who leave because of the economic and political uncertainties." It has also recently "raised its dividend and plans to buy back 5 million in shares in the fourth quarter of this year and the same amount next year."

So much for increasing the real investment in the economy and for lowering the unemployment rate. So much for spurring on economic growth. It appears as if the consequence of the election is that corporations are expressing their view of the future of the economy. They are voting with how they use their cash!

The interpretation I give this picture is one of continued slow economic growth, lagging hiring of employees, and modest profit growth. And, within this picture, what is going to spur on earnings per share? Well, the number of shares are going to go down relative to earnings so that earnings per share will rise.

Will price per share go up? This is apparently what the corporations are hoping will happen. And, if price per share goes up then the stock market goes up?

In my post of November 14 I argued that the stock market will continue to go sideways, with the S&P 500 cycling between 1100 and 1500 during the second Obama administration. I see nothing in the material I have presented above to change my forecast.

What the new information on the amount of buybacks taking place does for me is to just confirm the weaknesses that exist in the economy. Companies are not investing in plant and equipment. Consumers are not stepping up their expenditures.

The housing market seems to be recovering … from a very low level … but there are questions about what is really going on in this sector. Furthermore, there is a question about who is really benefiting from this pickup. I was just at a holiday party this last weekend and some well-off guests at the party who talked about the fact that they were forming an LLC to purchase homes preparing for the inevitable rise in home prices because of all the money the Federal Reserve is pumping into the housing market.

And, there are a lot of small- and medium-sized commercial banks and small- and medium-sized businesses that are really not in that go of a financial condition.

Obviously, I am not currently very bullish on the economy or on the stock market. Unfortunately, this feeling extends out maybe three or four more years. It seems that there are quite a few corporate executives that feel the same way.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.