The Beginning of the End of the 'Buyback Boom'
A new front in the 'trade war'... Tensions with China are rising again... The beginning of the end of the 'buyback boom'...
Last Monday, we said we were skeptical the tentative 'trade truce' between the U.S. and China would last long...
Sure enough, by Tuesday morning, several White House officials were already tempering expectations of a potential deal. But the situation took another turn for the worse while U.S. markets were closed on Wednesday...
That morning, news broke that Canadian authorities – working at the request of the U.S. – had arrested Meng Wanzhou, chief financial officer of Chinese electronics giant Huawei, for alleged violations of U.S. sanctions on Iran.
This is a potentially huge deal...
After all, imagine how the U.S. government might respond if China unexpectedly arrested an executive at U.S. consumer-electronics giant Apple (AAPL) while traveling overseas. Yet, even that analogy doesn't fully capture the magnitude of this situation. You see, Meng is also the daughter of one of China's wealthiest and most-connected men. As the Wall Street Journal reported on Thursday...
The Huawei chief financial officer arrested in Canada at the behest of American authorities isn't an ordinary senior executive. Meng Wanzhou, 46 years old, is the daughter of the Chinese telecommunications giant's founder and recently emerged as his potential successor.
Ms. Meng's high profile raises the stakes not only for her company, but also for the U.S. and China, which are embarking on a fresh effort to resolve tensions around trade and technology. China's embassy to Canada has already complained bitterly about the arrest and other Chinese tech companies have been punished this year for sanctions violations and allegedly stealing chip-design secrets.
The Chinese government went even further over the weekend...
On Saturday, China's vice minister of foreign affairs, Le Yucheng, sent a summons to Canada's Chinese ambassador John McCallum, calling the arrest "lawless, reasonless and ruthless, and... extremely vicious." It also warned Canada of "serious consequences" if it didn't release Meng immediately.
On Sunday, Le summoned U.S. ambassador to China Terry Branstad in "strong protest against the U.S.' unreasonable direction to Canada of detaining the Huawei executive" and demanded the U.S. revoke the arrest warrant or that it would take further action in response.
For its part, the White House says the arrest was unrelated to the recent trade spat...
But the timing of the move is curious. At best, it's likely to make reaching any agreement significantly more difficult now. But if the Chinese government decides the U.S. was trying to coerce it into a deal, there's no telling how it could respond.
In other news, regular Digest readers know debt-fueled share buybacks have been one of the biggest drivers of this long bull market...
Companies have borrowed hundreds of billions of dollars to help push their stock prices higher over the past several years. Yet as our colleague Mike DiBiase reminded readers late last month, this trend can't continue forever. As he explained in the November 28 Digest...
Many companies have seen their debt loads grow to unsustainable levels. Taking on more debt will put them in danger of going broke. Corporate debt in the U.S. totals $9 trillion, the highest it has ever been. As you can see in the following chart, it's up nearly 50% from the end of the last financial crisis...
Measured against our gross domestic product (GDP), corporate debt is the highest it has ever been at 46%.
And it's not just the amount of corporate debt that's concerning... It's also the quality. Today, $3 trillion of debt is rated at the lowest level of investment-grade debt – by far the most than at any other time in history. These companies are teetering on the edge of becoming junk credits. By taking on more debt to buy back their own stock, they risk a credit rating downgrade and much higher interest costs.
Not only that, the cost of debt is increasing, too. After a decade of artificially low interest rates, rates are on the rise once again, making debt-funded buybacks more expensive. Many companies are bloated with debt and can barely afford to pay the interest today.
In short, while the buyback boom could continue a while longer, the end is now near. As Mike explained...
Beginning next year, I expect we'll see buybacks decrease for the first time since 2009. As the pace of buybacks slows, one of the biggest forces behind this bull market will disappear... And that could lead to the end of the longest bull market in history.
Again, these buybacks won't cease overnight...
But we're already seeing signs that the winds are changing. Suddenly, companies are finding it much more difficult to raise new debt to fund these purchases. As Bloomberg reported last week...
For a decade since the financial crisis, U.S. companies have piled up debt to fund generous equity buybacks, helping supercharge a fourfold jump in the S&P 500 Index in the process. But as scrutiny on company financial health mounts, creditors are seeking to wrestle back control and curb these balance-sheet-be-damned maneuvers.
Already, U.S. companies are curtailing the amount of bonds sold to buy back their own stock by a third in 2018, based on a Bloomberg data search of transactions detailing use of proceeds...
It all points to a reversal of the type of shareholder-friendly activity that propelled the S&P 500 to dizzying peaks this year... The drop in issuance volumes is illustrative of a growing trend: Corporate America is facing a wake-up call as once-acquiescent bondholders balk at funding rewards to equity owners.
Expect to hear much more about this trend in the year ahead.
New 52-week highs (as of 12/7/18): MarketAxess (MKTX).
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December 10, 2018