One of the tenets of central bank policy has been that free or cheap money would lead to companies investing for the future, given that their cost of capital had decreased and therefore more projects would be viable. The irony is that, as I have alluded to in the heading of this article, the exact opposite has taken place. Companies have instead resorted to financial engineering, by buying back their shares and in many cases issuing debt to do so, given that the cost of debt has been so cheap. Instead of building for the future, they have done the opposite, cancelling shares and artificially inflating earnings.
Since 2009, companies that have embarked on this strategy have outperformed the market, as can be seen in the graph below, but in 2015 this started to unravel and we are starting to see the opposite. It would appear that investors are waking up to the fact that simply buying back shares is not a growth strategy, particularly with the cost of debt starting to rise and balance sheets beginning to get stretched.
To better illustrate their impact (according to the good folk at Kames Capital), aggregate S&P 500 earnings would have actually declined in the third quarter of 2015, had it not been for those share buy-backs. It is further estimated that, over the last 15 quarters, share buy-backs have boosted the US market’s Earnings Per Share (EPS) growth by an average of 1.4 per cent (n.b. per quarter, not per annum).
Should US interest rates rise further, some companies will be unable to repurchase shares at the current pace. Higher debt means higher interest payments, which companies will need to pay for using cash that has been previously spent on buying back their shares. As companies slow or stop repurchasing, investors may in turn realise that these companies are no longer growth companies, and the ultimate consequence would be a decline in share price.
The long and short of all of this, is that share buy-backs are yet another example of the unintended consequences of central banks’ efforts to stimulate global growth – as elsewhere, their attempts to manipulate markets have resulted in the exact opposite. Their latest policy of negative interest rates is a story for a weekly view to come.
Unintentional Consequences - Weekly Comment
