Declining Profits, Rising Defaults Assure 2016 Recession

Will a 2016 US recession be the next big one?I believe a 2016 recession is already a fact in the US, and the Great Recession will return with a vengeance. That recession never really ended. It was simply propped up while all of its fundamental flaws remained, and the props are now all ended or failing. It will ultimately become the mother of all recessions. Even the Great Depression has nothing up on what we are now entering.

GDP estimates are increasingly moving in favor of my prediction that the US has been entering a recession since the start of 2016. (Keep in mind recessions are always declared after the fact — after quarterly statistics are in. That’s why I call it a “prediction,” even though I say we have already entered it. The prediction is that it will eventually be declared, but not for many months.)

End of stock buybacks triggers 2016 recession in the US

I’ve noted on The Great Recession Blog a few times that the only force that has been sustaining high stock market values in the recent rally — now ended — has been the huge number of incestuous stock buybacks. The corporate elite have been saving themselves by desperate measures that will leave smaller investors holding crashing shares. When the shares are done crashing, the elite investors will come back in with their cash and thereby profit from the crash.

In stock buyback programs, companies create their own demand for their stocks by taking out low-interest loans to buy their own shares back. Sometimes the major investors on the board make this decision and focus on buying their own shares back. Those extraordinary measures to create stock value are now ending, partially for temporary reasons and partially, it seems, as a reversal in the buyback trend (maybe because board-member aims of cashing themselves out have been achieved).

As a result, we see the recent stock rally has hit a new ceiling. Goldman Sachs reported earlier this week that the end of stock repurchases threatens the rally, and we can now see that the rally has been threatened practically to death as it now struggles against the market’s lowering ceiling like a hero in one of those rooms where the ceiling keeps coming down inch by inch until it crushes you. Since the end of QE, buybacks have formed the primary demand for stocks while the kinds of economic factors that ordinarily create demand have receded.

We’d say the next month would be weaker rather than stronger because you have no corporate repurchases, which are a key source — the only source — of demand for shares. Then you’ve got your core earnings, which are likely to be muted. So there’s an absence of drivers for why the market goes higher. (NewsMax)

Right now the market is in a lull because buyback support is not there, but reports of lower corporate earnings have not started to hit it yet either. I’ve noted that buybacks get curtailed while companies issue their reports for the previous quarter and that the reduction in buybacks would end the rally they have supported. Thus, we see a rally that finished off with a lower ceiling than previous rallies.

You have to be able to recognize that buying back your own stocks is not a sustainable path for creating stock value. If it were, companies would just start out by issuing stocks to the company, forgetting investors altogether and skip entering the New York Stock Exchange. Hopefully, putting it that way makes it clear why a rally based on stock buybacks cannot be sustained. It is, if anything, how corporations end themselves, not how they save themselves. At best, it is a temporary boost.

Not only have buybacks been curtailed as companies ready for the reporting season, but they have been diminishing on a quarter-on-quarter basis. CNBC reports that the buyback fuel for the seven-year bull market is losing steam as a trend, not just as a short-term matter in the lead-up to the present reporting period:

Share repurchases decreased 3.4 percent in the fourth quarter from the previous three-month period and are tracking at a 21-month low in March, according to respective data from S&P Dow Jones Indices and TrimTabs. If the trend continues, that would mark a major trend shift. Companies have been using reductions in share count as a way to boost earnings profiles, raise stock prices and reward corporate executives. The programs have been seen as a major driver of the market rally, though the extent of the effect has come under scrutiny in recent months…. However, the pendulum could be turning, due in part to several factors. One obstacle to buybacks is the market simply getting more expensive.

February saw a buyback leap because stocks lost so much value in January that companies leaped in with more buybacks to save themselves and because it is sensible to buy back shares when they are a bargain rather than when they are priced high. That began winding down again in March because the buyback rally raised prices.

You see, any rally created by buybacks is ultimately self-defeating as companies are less inclined to purchase back their stock when the value is rising or high, unless they are purchasing back stocks solely from the board members and other major stock holders who want to cash out. When you have players with a lot of stocks to dump, buybacks are a way to keep the dump from crashing the stock’s value. In which case, buybacks continue until the major players who want out have exited.. Buybacks can bridge a company through a slump, too, but they don’t work for longterm gain.

Buybacks are self-defeating as a longer-term support to the market because, when they run on for too long, savvy investors become wary. Buybacks happen at the cost of capital investment that cash and credit could go toward if it were not being poured into buying back shares. So, buybacks happen at the cost of a company positioning itself for the future.

You can do that short-term and maybe not feel it much. You can never do it long-term and succeed. Old-fashion investors, who still like real value, lose interest in companies that are not creating value by doing what they could be doing with that same money in research and development or in upgrading manufacturing equipment, etc.

Call it “financial fatigue.” True investors eventually tire of stock values that only rise because of financial engineering.

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