Recap 2014-08-06


Below is an interesting article that is bearish on equities. It is not a new idea, (there are actually lots of articles that address this topic) but it does present a bit of data that I haven’t seen before. Take a read:

So I think most reasonable people would finish that article nodding. The basic premise of most of the implications are reasonable – companies can’t borrow to buy back stocks forever, interest rates are low and will rise, companies tend to buy back the most amount of stock at the top of the market. As a result, it would also be reasonable to accept the conclusion – that stocks are set for a nasty fall once the buybacks stop.

Except those points avoid addressing the key issue: why are companies doing this? By omitting that, the assumption essentially becomes that all those items above are mean reverting. Which is perhaps oftentimes a safe thing to assume, but in this case is wrong. (side note: IMO most incorrect investment theses are wrong because of incorrect assumptions) There is, in fact, just one observation that is required to explain all of the points above, and in fact suggests that those trends are likely to continue rather then revert. That is: nominal growth rates now are significantly lower than before the crisis, and will remain that way for the foreseeable future.

The progression is as follows:

  1. Growth rates are lower
  2. Discount rates are lower
  3. Bond prices have adjusted to the lower discount rates – and are likely to stay there because it is a secular phenomenon
  4. Equities prices have not (yet fully) adjusted to the lower discount rates
  5. Thus there is a large discrepancy between the high cost of equity vs both the low growth rate or the secularly lower cost of debt
  6. This means it makes a LOT of sense for companies to use cash flows from operations and debt to buy back stock, rather than reinvest in capex or pay down debt
  7. Companies cannot forecast recessions better than anyone else, so because it makes sense that they continue buybacks until a recession impacts cash flows from operations and/or financing. The fact that buybacks tend to peak along with the market should not be a surprise, nor should it be a reason to avoid buying stocks.
  8. A final point: total equity purchases, including buybacks, does NOT need to increase for stock markets to go up. For every buyer, there is a seller, and total equity volume has been falling for several years now. This means that aggregate purchases can fall inline with volume and the market does not have to go down.

I’ve touched on these topics before, and I think that some market participants have already started to come to this view (Blackrock was early on this also) but in aggregate it is still far from consensus. There are signs that people are catching on though, albeit slowly. A month ago the NY Times ran an article entitled “Welcome to the Everything Boom, or Maybe the Everything Bubble.” It missed the real reason for that phenomenon, but it does provide support for it. Lower discount rates are raising the present value of all financial assets – not just equities. In other words, higher equity prices are not an anomaly relative to the entire universe of investable dollar assets.


  • Italy GDP fell -0.2% QoQ vs +0.1% exp and -0.1% prev. ISTAT also reports that net exports have contributed negatively to quarterly growth, while domestic demand’s support was neutral.
  • NZ Employment declined to 5.6% in 2Q vs 5.8% exp and 6.0% prev. However, this was driven by a drop in the participation rate to 68.9% vs 69.3% exp and prev. Wages rose 0.6% QoQ vs 0.5% exp and 0.3% prev.
  • : The world’s largest institutional investor has sounded the alarm over the quality of European IPOs as hedge funds increase their bets against private equity-backed flotations, after the market for companies going public was soured by a string of high-profile failures. BlackRock said the flotation process needed to be improved, after the best six months for European IPOs since the financial crisis was ruined by poor market debuts from companies including Saga, the UK retirement group, Applus, the Spanish industrial testing business and eDreams Odigeo, the online travel agent. BlackRock tracked 104 IPOs in Europe in the first six months of this year, of which 38 deals – just over a third – are trading below their issue price. The Eurostoxx index is down around 0.5 per cent so far this year. Twenty companies which had been planning to go public – including names such as retail chain Fat Face – pulled their flotation. This year €33.7bn has already been raised in the European IPO market, more than in any full year since 2007, according to PwC.


  • Wed: Australia Employment
  • Thu: BoE, ECB, Canada Building Permits, US Jobless Claims, Australia Home loans, Japan Eco Watchers
  • Fri: German Current Account, Canada Employment, US Unit Labor Costs, China CPI
  • Mon: Canada housing Starts, Australia NAB Business Confidence, House Price Index
  • Tue: German ZEW, US NFIB Survey, WASDE reports, Japan 2Q GDP