Tuesday, May 17, 2016

More on QE distortions - the business of business is finance

FT points to the irony of top tier US corporates, who are flush with more than $2 trillion in cash reserves, borrowing heavily to finance share buybacks that boost stock prices and in the process contributing to the inflation of a bond bubble. And this is not all,
The buyback bubble is only one part of a larger trend, which is that the business of corporate America is no longer business — it is finance. American firms today make more money than ever before by simply moving money around, getting about five times the revenue from purely financial activities, such as trading, hedging, tax optimisation and selling financial services, than they did in the immediate postwar period. No wonder share buybacks and corporate investment into research and development have moved inversely in recent years. It is easier for chief executives with a shelf life of three years to try to please investors by jacking up short-term share prices than to invest in things that will grow a company over the long haul. It is telling that private firms invest twice as much in things like new technology, worker training, factory upgrades and R&D as public firms of similar size — they simply do not have to deal with market pressure not to... the financial industry... has roughly doubled in size as a percentage of gross domestic product over the past 40 years. As finance grew, so did its profits — the industry creates only 4 per cent of US jobs yet takes around 25 per cent of the corporate profit share.
The distortions engendered as non-finance firms seek to emulate their financial sector counterparts at a time when the economic prospects look none too attractive serve to destroy long-term value and further weaken economic prospects,
Airlines, for instance, often make more money from hedging on oil prices than on selling seats — even though it undermines their core business by increasing commodities volatility, and bad bets can leave them with millions of dollars in sudden losses. GE, America’s original innovator, only recently stopped being a “too big to fail” bank. The pharmaceuticals industry, perhaps the most financialised of all, has cut nearly 150,000 jobs since 2008, most in R&D, as companies focus instead on outsourcing, tax optimisation, inversions and “creative” accounting in ways that make them look suspiciously like portfolio management companies — a group of disparate firms operating separately and trying to make as much money as quickly as possible, with little thought to the long-term impact of their decisions. Even Silicon Valley is not immune. Apple and other tech behemoths now anchor new corporate bond offerings as investment banks do, which is not surprising considering how much cash they hold. If Big Tech decided at any point to dump those bonds, it could become a market-moving event.
Granted that many of these trends pre-date the post-crisis quantitative easing. But only the naive would not concede that the QE, with its flood of cheap capital with no end apparently in sight, has sustained and amplified these trends. 

Update 1 (04.11.2017)

John Plender points to the misalignment between CEO compensation and business performance and highlights research by Robert Ayers and Michael Olenik which presents an assessment of share buybacks,
In a data set of 1,839 US firms they noted that 535 firms that repurchased less than 5 per cent of the market value saw their market value increase by an average of 248 per cent over the latest five-year period. The 64 firms that repurchased 100 per cent or more of their market capitalisation experienced a 21.7 per cent decline in value over the same period. That group included such well-known names as Sears Holdings, JC Penney, HP Inc, CBS, Macy’s, Nordstrom, Motorola, IBM, Symantec, Xerox, Office Depot, VeriSign and Target Corporation.

1 comment:

Paul said...

Wasn't this exactly how it went in Japan before the bubble burst?