Financial Engineering Continued To Dominate Business In 2016: Will Trump Change The Picture?

by: John M. Mason


Financial engineering continued to dominate the corporate world in 2016 as stock buybacks and big, undoable mergers continued to capture headlines.

Chief executives have not found sufficient incentives to grow their corporations internally and so have resorted to other means to raise stock prices and attain greater size.

If the Trump administration is to build a successful economic policy, it must create incentives for these chief executives to refocus on internal corporate growth and reduce financial engineering.

Two major pieces of evidence support the assertion that financial engineering dominated corporate decision making in 2016. This continued to account for the small amount of resources corporations allocated to capital expenditures, which contributed to the slow growth of the United States economy.

The question for 2017 has to do with whether or not the incoming Trump administration can alter the incentives that exist that result in this financial engineering and re-direct the efforts of United States corporation toward greater amounts of capital expenditures.

The two pieces of evidence are the end-of-year surge in stock buybacks, see the Wall Street Journal article, "Surging Buybacks Fuel Stock Boom," and the New York Times article, "A Year of Big Risks and Spectacular Flops."

In the first article, we read, "Corporate stock repurchases are on the upswing once again, wrong-footing skeptics who predicted 2016 would mark the beginning of the end of a postcrisis spending spree."

"After repurchases hit a record in 2015, they had slowed this year. Many analysts predict they will decline next year, reflecting soft corporate earnings and stretched stock valuations."

But, the Trump election has altered the view.

"Through December 16, companies this month have stepped up buybacks by nearly two-thirds over the same period last year, according to Goldman Sachs Group Inc."

Furthermore, "the election surprise has raised the prospect that tax cuts will put large sums in corporate coffers, which in turn will be deployed largely in repurchases. That money potentially could include the profits that U. S. companies stand to bring back from overseas under a widely expected repatriation-tax holiday."

"Goldman Sachs forecast that S&P 500 companies will repatriate $200 billion of their $1 trillion in cash held overseas in 2017 and that $150 billion of those funds will be spent on share repurchases."

What about capital expenditures?

In the second article cited, we also learn about the big surge in the failure of making business deals in 2016.

"It may not have been a banner year for striking deals, but 2016 was clearly a time for breaking them."

"This year was the biggest in terms of volume for busted transactions-those withdrawn after being announced-since the depths of the financial crisis eight year ago…."

"Some 1,009 takeovers worth $797.2 have been scrapped this year as of last Tuesday, according to Thomson Reuters, a volume that had not been seen since 2007 and 2008."

Some of the deals were turned down because they "were likely to lead to too much market concentration."

But, is interesting that the other major reason given for the "busted transactions" was the over reach that "filled corporate chieftain's heads during the past two years" that were "born of heady ambitions."

"Chief executives and their bankers and layers pursued big, risky transactions that they were largely unable to achieve on their own."

That is, the chief executives could not achieve the size they desired by investing in their own companies… so, they tried to buy other companies to achieve what was impossible for them, separately.

There was lots of cash around… and debt was at historically low levels… and the economy was not robust enough to allow individual companies to grow…and so the chief executives put their energy into buying what was around them.

In other words, chief executives could not find sufficient justification in the economy of 2016 to expand their businesses in the normal way of expanding through business capital expenditures.

And, this is the environment facing the Trump administration as it takes office on January 20, 2017.

Will the Trump administration be able to get corporate leadership to move away from financial engineering and re-direct their efforts to growing companies and building stock market value in the "old fashioned way"… through business capital expenditures.

In the first article cited above, we read that Goldman Sachs thinks that stock buybacks will continue into 2017… and beyond. If stock buybacks continue in large numbers, efforts to build companies through capital expenditures will continue to lag.

Additionally, if corporate leaders do not find an economy that is growing faster, it will continue to put resources into finding acquisitions rather than putting those resources into their company's capital base.

Corporations need a solid base of economic growth to expand internally so as to improve productivity and to build their physical base.

That solid base of economic growth has not been present over the past seven and one-half years. Chief executives would not have been driving their companies in the directions they have if this was not true.

A problem the Trump administration might face is that Trump is a "deal maker." Deal making is a part of financial engineering. Deal making will not, in and of itself, make the economy grow faster.

And, here is a place to observe whether of not the Trump administration can alter the economic incentives that now exist within the economy. If stock buybacks continue at high rates, and if corporations continue to try and extend themselves through "impossible" acquisitions, then one could argue that the Trump administration's economic policy is failing.

If stock buybacks decline and if corporations begin to focus more on building their businesses internally, then one could argue that the Trump administration's economic policy is achieving some success.

Disclosure: I/we 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.

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