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Was corporate profit growth a bubble inflated by "financial engineering"?

207 points by timlangeman 7y ago

deleted 7y ago
[deleted]
pedro2 7y ago
Yes. Nothing to see here, move along.
- alexpetralia 7y ago
  This is unnecessarily dismissive..
  - pedro2 7y ago
    Yes. I shouldn’t have clicked Submit - it was out of frustration. It’s one of those things we won’t know except in hindsight. So: frustrated at the situation and at the article and at my inability to grasp what the hell is going on on markets. Misquoting Scott Adams, we have now Confusomarkets. Though probably they were always confusing but the more I try to interpret them logically the more duped by them I am. The only move is to be cynical, which gets me depressed. /rant
    - salawat 7y ago
      You probably do grasp it better than you think. For instance; you know people have gotten laid off in record numbers. That means people aren't getting paid. People who aren't getting paid are clamping down on any expenditure possible aside from absolute necessities. That means, if you're entertainment in any way, you are likely hosed unless your specialty is direct to consumer last mile service. Production/producers may see some growth. There may be more growth in sectors that enable remote work/telepresence. Otherwise, just about everything else will be dropping, and stimulus will likely slow the drop but not reverse it until the pandemic has run it's course sufficiently that healthcare systems are no longer overwhelmed. Most likely, other shareholders are seeing this too, and are trying to cash out, further fueling the drop in share prices across the board. The people who correctly timed the market have already gone and converted their assets to cash, which is king in deflationary periods. The stimulus might provide some liquidity/stimulated demand, but I have the feeling a liquidity trap situation may occur where people will hold onto any injected value for dear life. I wouldn't hold much faith in any type of securitized asset right now unless it's from a big (established) player; and Note that that isn't necessarily "good" for the economy if that complacency gets noticed and acted upon by major players. It may be a good time to look at a new entrant who is providing a service to ease the pains created by the new pandemic; just make sure to do due diligence, because the fraudsters all know that too. Collectively, I think we're going to have to come to terms with deflationary period. I don't think it can be avoided. At least we shouldn't have to worry about stagflation in the same way They did in the 70's. Oil is uh... Quite plentiful. Unfortunately for those long in the petroleum industry.
klysm 7y ago
"When a measure becomes a target, it ceases to be a good measure." (Goodhart's law) Does this apply here? It seems you could argue that profit is the one true number that _is_ a good measure, but it seems even that can be 'hacked' so that it isn't good anymore.
- SpicyLemonZest 7y ago
  It's a good argument for why companies shouldn't monomaniacally focus on profit, but in practice they don't really seem to do that in the first place. (In fact, one of the prevailing concerns about the recent stock market has been that it focused too little on profit, with many large tech companies trading at extreme multiples of their earnings based on stories about how cool and important they are.)
- Majromax 7y ago
  Money returned to shareholders is the "one true number," even moreso than profit. Retained earnings are only valuable insofar as investors expect them to be returned in the future -- a company that pays no dividends, buys back no shares, cannot be bought out, intends to operate until it goes insolvent, and cannot have a new board brought in to change these policies is "worthless" as an investment vehicle. So in principle there's nothing wrong with the buybacks. However, investors can have the mistaken impression that these buybacks would continue into the future, and predictions of the future -- and thus the fair stock price -- can change in a heartbeat.
- TeMPOraL 7y ago
  > It seems you could argue that profit is the one true number that _is_ a good measure A measure of what? As a proxy for social utility, it's been thoroughly gamed and the two have little correlation. Profit is currently used as a self-serving measure, because you can eat profit (after exchanging it for bread, or drugs, or yachts). In this sense it can't be hacked. Accounting around it can be and is, though.
LeoTinnitus 7y ago
It's certainly more nuanced than that. However, it does point out the fact that corporations focus too much on shareholder value as opposed to just making a good business system...except for the major players that is. These the so called "too big to fail" types of companies which borderline monopolize market sectors like Amazon and Walmart. But they don't care during recessions because they're fine. They essentially are the government as they have a larger impact on your daily life than the actual government! It's not so much that the stock buybacks are the straw that broke the camel's back, it's just another inevitable economic event that the invisible hand dealt. There is no stopping it. Otherwise we're just back in a labor economy again where money can't flow where irrational people deem they need to place it.
- BlackCherry 7y ago
  It’s not the “corporations” as this abstract entity that are focusing on shareholder value as a top priority. It’s the C Suite members, and it’s the board members... it’s a small group of people at the top who are trying to enrich themselves at the expense of the company and at the expense of the people who actually run the company.
  - softwarejosh 7y ago
    under the guise of enriching the company through stock growth
  - LeoTinnitus 7y ago
    Yes that is most definitely true. The intent isn't for your company to go spiraling down into bankruptcy. The problem is these bourgeoisie types at the top don't change even after getting bailout money. Why the hell are we rewarding the people who maintain a company culture of "Well if we go bankrupt, we'll just ask the government for money cause they can't afford for us to go out of business!" It's a load of crap that this is even a concept if the government cannot get involved at that point.
- jimmaswell 7y ago
  > They essentially are the government as they have a larger impact on your daily life than the actual government! Amazon and Wal Mart could disappear overnight and I would just shop elsewhere. Amazon isn't in charge of my water quality or road maintenance.
kaesar14 7y ago
I find this scary and telling. "It is too early to say where the bottom is to this recession, but we have reason to believe the Millennials and Generation X do not have the resources to purchase the stock that Baby Boomers want to sell at prior market highs. With Corporate profit growth unmasked and the Baby Boomer’s transition into retirement, it seems unlikely that stocks will make a quick return to their prior levels unless governments engage in massive asset inflation." It's almost like bankrupting a generation by forcing them through punishingly expensive higher education, obscene healthcare costs, absurd cost of living in major metropolitan areas, and stripping worker benefits makes an entire generation of this country's youth unable to prosper like their predecessors. I truly have no idea what will be left behind for me and my peers, when all of this is said and done.
- JMTQp8lwXL 7y ago
  Corporations are the largest net purchasers of stock. The narrative was never "generations of ordinary people will support prices". Because ordinary people control proportionally small amount of the nation's total wealth.
  - kaesar14 7y ago
    But those stock prices can never go down because of how much generational retirement wealth is locked up in financial markets.
    - cdblades 7y ago
      I don't see how this addresses the comment you're replying to. The last month of cliff-fall would suggest your premise is wrong: prices absolutely can go down.
      - kaesar14 7y ago
        I should amend my point to say that stock prices cannot acceptably fall without massive intervention by the government. The system is set up so that those who have the most invested in the market (mostly the older generation who are trying to retire, institutional investors, high net worth individuals) will do anything to prop those prices up, and the government will listen because it's beholden to the interests of the older and the wealthy. They'll bankrupt this nation's economy for those that will inherit it to save those retirement funds at the benefit of wealthy investors.
tathougies 7y ago
Do people not expect the market to go down when business revenues have been forced lower due to unforeseen circumstances? The fact is a valuation made in November 2019 had no way of taking this into account. This isn't to say whether or not it's a bubble, but I am surprised at the number of people who think that stock prices going down is due to financial health of companies rather than people attempting to sell stocks either in a panick or because they suddenly need the liquid cash on hand (due to job loss) and are thus willing to sell at a loss. And regardless of their merits or demerits, share buybacks do increase actual earnings per share, which is one method to valuate shares. It's like, if there are four partners in a partnership and two decide to buy out the other's shares, their shares are now worth twice as much, assuming the corporation continues making revenue. Then I hear about corporate debt and how that forces layoffs. The fact is companies are not going to retain employees when they cannot conduct business, regardless of cash on hand. It's not even a moral concern. Companies can simply layoff their employees and have them receive unemployment insurance. Even if they wanted to be 'ethical' and provide health insurance, the cost of a severance package with 18 months of health insurance is less than paying them and providing health insurance. From a corporation's perspective, irrespective of how much cash or debt they have, layoffs are simply superior.
- 01100011 7y ago
  > I am surprised at the number of people who think that stock prices going down is due to financial health of companies The financial health of many companies is significantly affected by virus mitigation strategies. Companies that were healthy in January may be on the brink of insolvency in June. The market is pricing that in to some extent.
  - tathougies 7y ago
    Yes, this is due to the virus, not the previous financial health of the companies. YOu have companies in danger of folding because creditors may be hesitant to give fixed-term loans to a company for which no one can determine a business resumption date. That does not reflect on the pre-virus financial health of the companies. Any company would find trouble with liquidity when its business model has been suspended suddenly and indefinitely.
pathseeker 7y ago
Blog spam that is effectively just a gish gallop of weak points that are each contentious on their own and it uses citations of Seeking Alpha which is about as good as a citation of Medium.com.
resters 7y ago
One use of financial engineering is to distill risk into very narrow products that allow innovative instruments to be created. The problem is that systemic risk is then distilled out of the priced instruments that are created, yet those instruments are significantly more vulnerable to systemic risk than simple equities, etc.
deleted 7y ago
[deleted]
kqvamxurcagg 7y ago
The bubble has been enabled by the Federal Reserve. Quantitative easing and money printing has served to inflate asset prices over many years. For some reason markets going up is fine but when they inevitably decline sharply this is viewed as 'disorderly' and the Fed prints money to keep asset prices high. The Fed ensures that hedge funds have counter-parties to buy their toxic overvalued assets. It's now clear that our economic system is run for the benefit of corporations and hedge funds.
- anthonypasq 7y ago
  > It's now clear only if you haven't been paying attention
- fbonetti 7y ago
  The Fed also kept interest rates near zero for years after the last recession. That’s where all the cheap credit came from in the first place.
- Ididntdothis 7y ago
  2008 made that blatantly clear.
- abakker 7y ago
  Everyone always seems to knee-jerk forget that corporations are employers...the economy is run for people. People work for companies. Companies compete, and the financial gymnastics they do to get there is done by people also. Companies are not sentient. (you could argue that they have some meta-sentience, but it is pretty unspecific)
  - ej3 7y ago
    Honestly I've always shared a perspective much like this until yesterday someone mentioned that through the stimulus (I'm not sure of the figures, but what I roughly recall is) each citizen gets $1200 they're then taxed on, and companies get the balance as an interest free loan. If the balance of the stimulus had been simply evenly distributed to individuals, everyone would have received nearly $10,000. I can't imagine what would happen if you gave every citizen 10k. I would think there would likely be something akin to a revolution that may or may not result in a more robust economy. What the gov't is doing by giving so much money to existing companies that have already failed vs individuals with the possibility of failing is very much protecting the existing social structure of society. Corporations like these are a hierarchy that generate implicit social striations in our society. By maintaining this regardless of the fundamental success of the product or competence of the management, they act only to preserve the class structure enforced by the institution and thus the stability of society in a configuration with marginal utility as regards productivity. They're clearly ensuring their own future.
amiune 7y ago
The amazing thing about bubbles is that you can only know that was a bubble only after it explodes but you can never predict it before.
- TheOtherHobbes 7y ago
  Before 2008 it was amazing how many people outside of economics, finance, and politics were able to see a disaster coming, but almost everyone in those sectors was completely blindsided.
  - bcrosby95 7y ago
    There's plenty of proof that people in those industries saw it coming. The question was when. Some people in them even thought it would pop years before 2008. If you acted on that then you lost despite being right because you didn't get the time horizon correct.
  - amiune 7y ago
    Ok so we just need those people to write a precise definition of "bubble" so we all can see it coming
  - sokoloff 7y ago
    How many of those people held that same view for 5 years before finally being right? It’s easy to call a market reversal if you’re comfortable calling 9 of the next 2 reversals.
skoczko 7y ago
Here's what I don't get: this article claims that big (since that's what matters for stock market index levels) business sits on a mountain of debt. At the same time many economists (e.g Yanis Varoufakis) claim that big business sit on mountains of cash kept in tax heavens rather that "working" for the benefit of the economy. Which way is it and are there any confirmed statistics to check it?
- zyang 7y ago
  Both. Racking up domestic debt using offshore cash as collateral. It's like getting a low interest loan using your 401k.
  - skoczko 7y ago
    Ok, thanks. Then the premise of this article is even weaker. Companies do generate huge profits albeit most of the hidden through accounting engineering. It's more likely that the inflated stock prices represent the actual "value".
    - lotsofpulp 7y ago
      And a lack of better places to put the money.
vimota 7y ago
OSAM has a great data-driven analysis of this question and end up on the other side in the conclusion: https://www.osam.com/pdfs/whitepapers/_2_Commentary_BuybacksBearsBulls_Oct-2016.pdf https://www.osam.com/pdfs/whitepapers/_2_Commentary_Buybacks...
- entee 7y ago
  So many problems with this analysis. 1.) main paper cited is from 2006, 2.) article is from 2016 3.) much of the data is older, several plots go to 2014 4.) almost no analysis that looks at long term profile of companies that do this over and over
LatteLazy 7y ago
One man's bubble is another man's under valuation. Big moves when there is big news (like a global pandemic say) are normal events. The thing I find concerning is why the FED are "intervening". Dumping cash made sense during a cash shortage. But when there are actual, real, concerns about the future (coronavirus), price falls are perfectly correct. They don't need "fixing". Happy to be corrected if anyone knows?
- treyfitty 7y ago
  The idea is similar to the previous financial crisis, except this time, it’s abstracted a layer higher. The previous crisis was a severe drying of credit that had (what they literally called it) a “contagion” and systemic effect. This time, there’s an actual contagious virus that is threatening the banking system if people can’t pay their bills, and the banks can’t pay who they owe because too many borrowers default. In other words, the Fed stepped in proactively because they saw the writing on the wall and wanted to avoid any drying of credit. The idea was never to keep the economy afloat- it was to build a bridge to prevent being exposed to the rough waters.
- francisofascii 7y ago
  You might be right, but this sounds like Austrian School policy thinking after the crash of 1929. That depressions are good in the long run, bankruptcies are fine, the economy will self correct, etc. https://en.wikipedia.org/wiki/Great_Depression#Common_position https://en.wikipedia.org/wiki/Great_Depression#Common_positi...
  - salawat 7y ago
    You can't really deny that ABCT hasn't been accurate in predicting the results of ongoing QE. I get mainstream econ looks down on it, but given the fact sticking strictly to Keynesian thinking has led to businesses being incentivized to create faulty product (Boeing), committing outright fraud (Wells Fargo), causing widespread destruction through abdication of due diligence (PG&E), exploiting addictive chemicals for business growth and engaging in unscrupulous price gouging (Shkreli, Pharma st al), and our current economic powerhouses are increasingly centered around consumer finacialization (every bloody major tech company), and for God's sake, Juicero happened; I'm honestly curious if the Austrian's might not be on to something. Maybe the market does need to crash down to the basics. I just don't know if there is really a way for that to happen at this point given how capital is so damn centralized right now. The problem is I just don't think it would be politically possible in the slightest to actually just sit back and hands off; and even if someone were that bold, they'd basically have just proven that there is no reason for them to exist as an institution anyway. Which I don't necessarily think is an inconceivable state of affairs, but I don't see the economists of the world throwing in the towel and admitting that willingly.
jlj 7y ago
How about taxing corporate stock buyback transactions at a high enough rate to make it hurt, and keeping the money set aside for social safety net and training programs that support the people who are losing their jobs. History has shown again and again that corporate tax cuts and repatriation schemes go right into stock buybacks and don't trickle down nearly enough to individuals. So tired of corporate welfare.
pjdemers 7y ago
Companies borrow money to buy back their shares because they can borrow for long terms at interest rates below the long term of inflation.
H8crilA 7y ago
Yes. Aggregate corporate profits have not gone up at all: https://fred.stlouisfed.org/series/A053RC1Q027SBEA https://fred.stlouisfed.org/series/A053RC1Q027SBEA There's a long way to go down to normalize this situation. I'm not saying this will happen, but the downside potential is enormous. Also, don't forget about the 50% of US GDP ($11T) that have been loaded into US capital markets (both debt and equity) by foreigners. This is also hugely out of balance: https://fred.stlouisfed.org/series/IIPUSNETIQ https://fred.stlouisfed.org/series/IIPUSNETIQ
- zxcb1 7y ago
  It wont, they just showed that they rather let the system explode than implode; the balance, proper self-organization, invisible hand etc, was lost ten years ago
  - H8crilA 7y ago
    Sadly, I believe you're right, and this scares the shit out of me. To put it bluntly - we will not have capitalism any more. Capitalism must provision for and handle failures, and this is not currently allowed to happen.
    - riffraff 7y ago
      The real question is: was it ever allowed to happen? There have been bailouts in some form since forever, it seems.
      - engineer_22 7y ago
        can you provide a list of examples?
        H8crilA 7y ago
        Everything the Fed, the BOJ, the ECB, the SNB and what have you are doing, reducing all the rates that they can: - starting from short riskfree rates [all since 1981, but problems surfaced only in 2008] - to long riskfree rates [all since 2008] - to corporate default rates [ECB since 2012, the Fed since 2020] - and in some cases, even to equity risk premium rates [BOJ and SNB since 2008] Also China, but China is special, and has a much more fine grip on things that goes far beyond the general rates (they can target sectors specifically, or even individual companies). Expect more alphabet soup of pump facilities to materialize. I don't bother listing them here, it's all the same (reduce this or that rate).
JMTQp8lwXL 7y ago
They've buried the lede. In the last sentence, in the last 6 words. > With Corporate profit growth unmasked and the Baby Boomer’s transition into retirement, it seems unlikely that stocks will make a quick return to their prior levels unless governments engage in massive asset inflation. It is not the Federal Reserve's mandate to inflate asset values, however it tends to be a consequence of their mission to support low unemployment and some stable, positive inflation. We have $6 trillion in emergency stimulus arriving shortly -- two thirds of that support is monetary policy.
mixmastamyk 7y ago
Is the sky blue? The Pope catholic? Vast money supply inflation, rock-bottom interest rates, stagnant wages, share buybacks. All accelerating over the last several decades.
gowld 7y ago
This wins today's award for least necessary question mark.
- alexandercrohde 7y ago
  I refuse to upvote on principle a one-liner quip on this site. But you're right, the insincere pretense of a question gives the air of a phony attempt at objectivity. Of course, that's entirely independent of whether the points are valid or not.
CrankyBear 7y ago
Conspiracy Theories R Us.
taurath 7y ago
Assets across the board are and were massively inflated because there's tons and tons of money out there any not enough investments for it.
andygcook 7y ago
There was an interesting interview with Chamath Palihapitiya on CNBC last week. Whether you like him or not, he made some good points around buy-backs and earnings per share manipulation. Worth listening to the full interview if you have 15 minutes: https://www.youtube.com/watch?v=NvEWez59fbI https://www.youtube.com/watch?v=NvEWez59fbI
- snarf21 7y ago
  Exactly, the Fed has artificially held rates low so companies are borrowing money for practically 0 to keep the price up and keep CEO compensation high. The only way to really fix the buyback problem is to outlaw stock based compensation for the C-suite and BOD. Then they might start focusing on long term corporate health instead of stock price and short-term quarterly numbers.
JackFr 7y ago
Issuing debt to buyback stock isn’t ‘financial engineering’ its trying to address the fundamental problem of corporate finance. You have two sources of capital, debt and equity. What is the optimal capital structure of the firm. There is no moral component as to whether a firm should be financed with debt or equity. While EPS has a smaller denominator, it also has a smaller numerator as earning will reflect the interest payments on the debt.
zuzun 7y ago
This reminds me of a paper I read in the Quantitative Finance section on arXiv.org, in which the author claimed stock markets are being manipulated by big portfolio owners, because the gains happen overnight, while the intraday returns are negative. I'm not endorsing this idea, but I consider it a fun conspiracy theory and maybe it's a good time to throw this into the discussion here. https://arxiv.org/abs/1912.01708 https://arxiv.org/abs/1912.01708
- raincom 7y ago
  Even if whatever this paper suggests is true, it won't contribute that much to the inflation of stocks. In this bull run, index funds have performed better than hedge funds. As long as the majority of investors (in terms of their aggregate holds) agree that the price of equities is fair, the ride will continue.
CapriciousCptl 7y ago
For a more balanced view, you can turn to JP Morgan's Guide to the Markets. It's a reliable summary of actual data so you can draw your own conclusions. https://am.jpmorgan.com/blob-gim/1383407651970/83456/MI-GTM_1Q20.pdf https://am.jpmorgan.com/blob-gim/1383407651970/83456/MI-GTM_...
- rayuela 7y ago
  This is an excellent deck. Thank you for sharing it!
- timlangeman 7y ago
  One of my main points is that you need to look beyond earnings per share to see the bigger trend. What slide/s would you use from the JP Morgan Guide that is better than the St. Louis Fed chart I featured? * https://fred.stlouisfed.org/graph/?g=qx3r The Chart on Page 7 looks fantastic but it is earnings per share, not total profits before taxes. The question I would ask is why the stock market graph looks so different than the St. Louis "Corporate profits before tax" graph? My hypothesis is that many of these companies borrowed a lot of money in the bond market to buy back their shares and thereby juice their earnings per share.
  - CapriciousCptl 7y ago
    I don't understand the point you're making. Stagnant corporate profits can happen for a lot of good reasons, particularly when there's GDP growth over the same period. Increased labor pay, increased competition, cheaper and higher quality products for consumers, long-term minded growth at the expense of short-term profit taking, etc. Profit also involves some major accounting nuances. In SAAS, for instance, advertising costs resulting in customer acquisitions are generally accounted for upfront, reducing accounting profits in the period of acquisition. This is opposed to other industries, where investments are more easily capitalized and then charged over their useful life.
kakoni 7y ago
In Europe we have this thing called “covered bonds”. In scandinavia Atleast half of the housing loans are packaged into these.
LatteLazy 7y ago
The first thing you learn in accounting school is which numbers are real (revenue) and which are made up (profit).

207 points by timlangeman 7y ago

deleted 7y ago

[deleted]

pedro2 7y ago

Yes. Nothing to see here, move along.

alexpetralia 7y ago
This is unnecessarily dismissive..
- pedro2 7y ago
  Yes. I shouldn’t have clicked Submit - it was out of frustration. It’s one of those things we won’t know except in hindsight. So: frustrated at the situation and at the article and at my inability to grasp what the hell is going on on markets. Misquoting Scott Adams, we have now Confusomarkets. Though probably they were always confusing but the more I try to interpret them logically the more duped by them I am. The only move is to be cynical, which gets me depressed. /rant
  - salawat 7y ago
    You probably do grasp it better than you think. For instance; you know people have gotten laid off in record numbers. That means people aren't getting paid. People who aren't getting paid are clamping down on any expenditure possible aside from absolute necessities. That means, if you're entertainment in any way, you are likely hosed unless your specialty is direct to consumer last mile service. Production/producers may see some growth. There may be more growth in sectors that enable remote work/telepresence. Otherwise, just about everything else will be dropping, and stimulus will likely slow the drop but not reverse it until the pandemic has run it's course sufficiently that healthcare systems are no longer overwhelmed. Most likely, other shareholders are seeing this too, and are trying to cash out, further fueling the drop in share prices across the board. The people who correctly timed the market have already gone and converted their assets to cash, which is king in deflationary periods. The stimulus might provide some liquidity/stimulated demand, but I have the feeling a liquidity trap situation may occur where people will hold onto any injected value for dear life. I wouldn't hold much faith in any type of securitized asset right now unless it's from a big (established) player; and Note that that isn't necessarily "good" for the economy if that complacency gets noticed and acted upon by major players. It may be a good time to look at a new entrant who is providing a service to ease the pains created by the new pandemic; just make sure to do due diligence, because the fraudsters all know that too. Collectively, I think we're going to have to come to terms with deflationary period. I don't think it can be avoided. At least we shouldn't have to worry about stagflation in the same way They did in the 70's. Oil is uh... Quite plentiful. Unfortunately for those long in the petroleum industry.

klysm 7y ago

"When a measure becomes a target, it ceases to be a good measure." (Goodhart's law) Does this apply here? It seems you could argue that profit is the one true number that _is_ a good measure, but it seems even that can be 'hacked' so that it isn't good anymore.

SpicyLemonZest 7y ago
It's a good argument for why companies shouldn't monomaniacally focus on profit, but in practice they don't really seem to do that in the first place. (In fact, one of the prevailing concerns about the recent stock market has been that it focused too little on profit, with many large tech companies trading at extreme multiples of their earnings based on stories about how cool and important they are.)
Majromax 7y ago
Money returned to shareholders is the "one true number," even moreso than profit. Retained earnings are only valuable insofar as investors expect them to be returned in the future -- a company that pays no dividends, buys back no shares, cannot be bought out, intends to operate until it goes insolvent, and cannot have a new board brought in to change these policies is "worthless" as an investment vehicle. So in principle there's nothing wrong with the buybacks. However, investors can have the mistaken impression that these buybacks would continue into the future, and predictions of the future -- and thus the fair stock price -- can change in a heartbeat.
TeMPOraL 7y ago
> It seems you could argue that profit is the one true number that _is_ a good measure A measure of what? As a proxy for social utility, it's been thoroughly gamed and the two have little correlation. Profit is currently used as a self-serving measure, because you can eat profit (after exchanging it for bread, or drugs, or yachts). In this sense it can't be hacked. Accounting around it can be and is, though.

LeoTinnitus 7y ago

It's certainly more nuanced than that. However, it does point out the fact that corporations focus too much on shareholder value as opposed to just making a good business system...except for the major players that is. These the so called "too big to fail" types of companies which borderline monopolize market sectors like Amazon and Walmart. But they don't care during recessions because they're fine. They essentially are the government as they have a larger impact on your daily life than the actual government! It's not so much that the stock buybacks are the straw that broke the camel's back, it's just another inevitable economic event that the invisible hand dealt. There is no stopping it. Otherwise we're just back in a labor economy again where money can't flow where irrational people deem they need to place it.

BlackCherry 7y ago
It’s not the “corporations” as this abstract entity that are focusing on shareholder value as a top priority. It’s the C Suite members, and it’s the board members... it’s a small group of people at the top who are trying to enrich themselves at the expense of the company and at the expense of the people who actually run the company.
- softwarejosh 7y ago
  under the guise of enriching the company through stock growth
- LeoTinnitus 7y ago
  Yes that is most definitely true. The intent isn't for your company to go spiraling down into bankruptcy. The problem is these bourgeoisie types at the top don't change even after getting bailout money. Why the hell are we rewarding the people who maintain a company culture of "Well if we go bankrupt, we'll just ask the government for money cause they can't afford for us to go out of business!" It's a load of crap that this is even a concept if the government cannot get involved at that point.
jimmaswell 7y ago
> They essentially are the government as they have a larger impact on your daily life than the actual government! Amazon and Wal Mart could disappear overnight and I would just shop elsewhere. Amazon isn't in charge of my water quality or road maintenance.

kaesar14 7y ago

I find this scary and telling. "It is too early to say where the bottom is to this recession, but we have reason to believe the Millennials and Generation X do not have the resources to purchase the stock that Baby Boomers want to sell at prior market highs. With Corporate profit growth unmasked and the Baby Boomer’s transition into retirement, it seems unlikely that stocks will make a quick return to their prior levels unless governments engage in massive asset inflation." It's almost like bankrupting a generation by forcing them through punishingly expensive higher education, obscene healthcare costs, absurd cost of living in major metropolitan areas, and stripping worker benefits makes an entire generation of this country's youth unable to prosper like their predecessors. I truly have no idea what will be left behind for me and my peers, when all of this is said and done.

JMTQp8lwXL 7y ago
Corporations are the largest net purchasers of stock. The narrative was never "generations of ordinary people will support prices". Because ordinary people control proportionally small amount of the nation's total wealth.
- kaesar14 7y ago
  But those stock prices can never go down because of how much generational retirement wealth is locked up in financial markets.
  - cdblades 7y ago
    I don't see how this addresses the comment you're replying to. The last month of cliff-fall would suggest your premise is wrong: prices absolutely can go down.
    - kaesar14 7y ago
      I should amend my point to say that stock prices cannot acceptably fall without massive intervention by the government. The system is set up so that those who have the most invested in the market (mostly the older generation who are trying to retire, institutional investors, high net worth individuals) will do anything to prop those prices up, and the government will listen because it's beholden to the interests of the older and the wealthy. They'll bankrupt this nation's economy for those that will inherit it to save those retirement funds at the benefit of wealthy investors.

tathougies 7y ago

Do people not expect the market to go down when business revenues have been forced lower due to unforeseen circumstances? The fact is a valuation made in November 2019 had no way of taking this into account. This isn't to say whether or not it's a bubble, but I am surprised at the number of people who think that stock prices going down is due to financial health of companies rather than people attempting to sell stocks either in a panick or because they suddenly need the liquid cash on hand (due to job loss) and are thus willing to sell at a loss. And regardless of their merits or demerits, share buybacks do increase actual earnings per share, which is one method to valuate shares. It's like, if there are four partners in a partnership and two decide to buy out the other's shares, their shares are now worth twice as much, assuming the corporation continues making revenue. Then I hear about corporate debt and how that forces layoffs. The fact is companies are not going to retain employees when they cannot conduct business, regardless of cash on hand. It's not even a moral concern. Companies can simply layoff their employees and have them receive unemployment insurance. Even if they wanted to be 'ethical' and provide health insurance, the cost of a severance package with 18 months of health insurance is less than paying them and providing health insurance. From a corporation's perspective, irrespective of how much cash or debt they have, layoffs are simply superior.

01100011 7y ago
> I am surprised at the number of people who think that stock prices going down is due to financial health of companies The financial health of many companies is significantly affected by virus mitigation strategies. Companies that were healthy in January may be on the brink of insolvency in June. The market is pricing that in to some extent.
- tathougies 7y ago
  Yes, this is due to the virus, not the previous financial health of the companies. YOu have companies in danger of folding because creditors may be hesitant to give fixed-term loans to a company for which no one can determine a business resumption date. That does not reflect on the pre-virus financial health of the companies. Any company would find trouble with liquidity when its business model has been suspended suddenly and indefinitely.

pathseeker 7y ago

Blog spam that is effectively just a gish gallop of weak points that are each contentious on their own and it uses citations of Seeking Alpha which is about as good as a citation of Medium.com.

resters 7y ago

One use of financial engineering is to distill risk into very narrow products that allow innovative instruments to be created. The problem is that systemic risk is then distilled out of the priced instruments that are created, yet those instruments are significantly more vulnerable to systemic risk than simple equities, etc.

deleted 7y ago

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kqvamxurcagg 7y ago

The bubble has been enabled by the Federal Reserve. Quantitative easing and money printing has served to inflate asset prices over many years. For some reason markets going up is fine but when they inevitably decline sharply this is viewed as 'disorderly' and the Fed prints money to keep asset prices high. The Fed ensures that hedge funds have counter-parties to buy their toxic overvalued assets. It's now clear that our economic system is run for the benefit of corporations and hedge funds.

anthonypasq 7y ago
> It's now clear only if you haven't been paying attention
fbonetti 7y ago
The Fed also kept interest rates near zero for years after the last recession. That’s where all the cheap credit came from in the first place.
Ididntdothis 7y ago
2008 made that blatantly clear.
abakker 7y ago
Everyone always seems to knee-jerk forget that corporations are employers...the economy is run for people. People work for companies. Companies compete, and the financial gymnastics they do to get there is done by people also. Companies are not sentient. (you could argue that they have some meta-sentience, but it is pretty unspecific)
- ej3 7y ago
  Honestly I've always shared a perspective much like this until yesterday someone mentioned that through the stimulus (I'm not sure of the figures, but what I roughly recall is) each citizen gets $1200 they're then taxed on, and companies get the balance as an interest free loan. If the balance of the stimulus had been simply evenly distributed to individuals, everyone would have received nearly $10,000. I can't imagine what would happen if you gave every citizen 10k. I would think there would likely be something akin to a revolution that may or may not result in a more robust economy. What the gov't is doing by giving so much money to existing companies that have already failed vs individuals with the possibility of failing is very much protecting the existing social structure of society. Corporations like these are a hierarchy that generate implicit social striations in our society. By maintaining this regardless of the fundamental success of the product or competence of the management, they act only to preserve the class structure enforced by the institution and thus the stability of society in a configuration with marginal utility as regards productivity. They're clearly ensuring their own future.

amiune 7y ago

The amazing thing about bubbles is that you can only know that was a bubble only after it explodes but you can never predict it before.

TheOtherHobbes 7y ago
Before 2008 it was amazing how many people outside of economics, finance, and politics were able to see a disaster coming, but almost everyone in those sectors was completely blindsided.
- bcrosby95 7y ago
  There's plenty of proof that people in those industries saw it coming. The question was when. Some people in them even thought it would pop years before 2008. If you acted on that then you lost despite being right because you didn't get the time horizon correct.
- amiune 7y ago
  Ok so we just need those people to write a precise definition of "bubble" so we all can see it coming
- sokoloff 7y ago
  How many of those people held that same view for 5 years before finally being right? It’s easy to call a market reversal if you’re comfortable calling 9 of the next 2 reversals.

skoczko 7y ago

Here's what I don't get: this article claims that big (since that's what matters for stock market index levels) business sits on a mountain of debt. At the same time many economists (e.g Yanis Varoufakis) claim that big business sit on mountains of cash kept in tax heavens rather that "working" for the benefit of the economy. Which way is it and are there any confirmed statistics to check it?

zyang 7y ago
Both. Racking up domestic debt using offshore cash as collateral. It's like getting a low interest loan using your 401k.
- skoczko 7y ago
  Ok, thanks. Then the premise of this article is even weaker. Companies do generate huge profits albeit most of the hidden through accounting engineering. It's more likely that the inflated stock prices represent the actual "value".
  - lotsofpulp 7y ago
    And a lack of better places to put the money.

vimota 7y ago

OSAM has a great data-driven analysis of this question and end up on the other side in the conclusion: https://www.osam.com/pdfs/whitepapers/_2_Commentary_BuybacksBearsBulls_Oct-2016.pdf https://www.osam.com/pdfs/whitepapers/_2_Commentary_Buybacks...

entee 7y ago
So many problems with this analysis. 1.) main paper cited is from 2006, 2.) article is from 2016 3.) much of the data is older, several plots go to 2014 4.) almost no analysis that looks at long term profile of companies that do this over and over

LatteLazy 7y ago

One man's bubble is another man's under valuation. Big moves when there is big news (like a global pandemic say) are normal events. The thing I find concerning is why the FED are "intervening". Dumping cash made sense during a cash shortage. But when there are actual, real, concerns about the future (coronavirus), price falls are perfectly correct. They don't need "fixing". Happy to be corrected if anyone knows?

treyfitty 7y ago
The idea is similar to the previous financial crisis, except this time, it’s abstracted a layer higher. The previous crisis was a severe drying of credit that had (what they literally called it) a “contagion” and systemic effect. This time, there’s an actual contagious virus that is threatening the banking system if people can’t pay their bills, and the banks can’t pay who they owe because too many borrowers default. In other words, the Fed stepped in proactively because they saw the writing on the wall and wanted to avoid any drying of credit. The idea was never to keep the economy afloat- it was to build a bridge to prevent being exposed to the rough waters.
francisofascii 7y ago
You might be right, but this sounds like Austrian School policy thinking after the crash of 1929. That depressions are good in the long run, bankruptcies are fine, the economy will self correct, etc. https://en.wikipedia.org/wiki/Great_Depression#Common_position https://en.wikipedia.org/wiki/Great_Depression#Common_positi...
- salawat 7y ago
  You can't really deny that ABCT hasn't been accurate in predicting the results of ongoing QE. I get mainstream econ looks down on it, but given the fact sticking strictly to Keynesian thinking has led to businesses being incentivized to create faulty product (Boeing), committing outright fraud (Wells Fargo), causing widespread destruction through abdication of due diligence (PG&E), exploiting addictive chemicals for business growth and engaging in unscrupulous price gouging (Shkreli, Pharma st al), and our current economic powerhouses are increasingly centered around consumer finacialization (every bloody major tech company), and for God's sake, Juicero happened; I'm honestly curious if the Austrian's might not be on to something. Maybe the market does need to crash down to the basics. I just don't know if there is really a way for that to happen at this point given how capital is so damn centralized right now. The problem is I just don't think it would be politically possible in the slightest to actually just sit back and hands off; and even if someone were that bold, they'd basically have just proven that there is no reason for them to exist as an institution anyway. Which I don't necessarily think is an inconceivable state of affairs, but I don't see the economists of the world throwing in the towel and admitting that willingly.

jlj 7y ago

How about taxing corporate stock buyback transactions at a high enough rate to make it hurt, and keeping the money set aside for social safety net and training programs that support the people who are losing their jobs. History has shown again and again that corporate tax cuts and repatriation schemes go right into stock buybacks and don't trickle down nearly enough to individuals. So tired of corporate welfare.

pjdemers 7y ago

Companies borrow money to buy back their shares because they can borrow for long terms at interest rates below the long term of inflation.

H8crilA 7y ago

Yes. Aggregate corporate profits have not gone up at all: https://fred.stlouisfed.org/series/A053RC1Q027SBEA https://fred.stlouisfed.org/series/A053RC1Q027SBEA There's a long way to go down to normalize this situation. I'm not saying this will happen, but the downside potential is enormous. Also, don't forget about the 50% of US GDP ($11T) that have been loaded into US capital markets (both debt and equity) by foreigners. This is also hugely out of balance: https://fred.stlouisfed.org/series/IIPUSNETIQ https://fred.stlouisfed.org/series/IIPUSNETIQ

zxcb1 7y ago
It wont, they just showed that they rather let the system explode than implode; the balance, proper self-organization, invisible hand etc, was lost ten years ago
- H8crilA 7y ago
  Sadly, I believe you're right, and this scares the shit out of me. To put it bluntly - we will not have capitalism any more. Capitalism must provision for and handle failures, and this is not currently allowed to happen.
  - riffraff 7y ago
    The real question is: was it ever allowed to happen? There have been bailouts in some form since forever, it seems.
    - engineer_22 7y ago
      can you provide a list of examples?
      - H8crilA 7y ago
        Everything the Fed, the BOJ, the ECB, the SNB and what have you are doing, reducing all the rates that they can: - starting from short riskfree rates [all since 1981, but problems surfaced only in 2008] - to long riskfree rates [all since 2008] - to corporate default rates [ECB since 2012, the Fed since 2020] - and in some cases, even to equity risk premium rates [BOJ and SNB since 2008] Also China, but China is special, and has a much more fine grip on things that goes far beyond the general rates (they can target sectors specifically, or even individual companies). Expect more alphabet soup of pump facilities to materialize. I don't bother listing them here, it's all the same (reduce this or that rate).

JMTQp8lwXL 7y ago

They've buried the lede. In the last sentence, in the last 6 words. > With Corporate profit growth unmasked and the Baby Boomer’s transition into retirement, it seems unlikely that stocks will make a quick return to their prior levels unless governments engage in massive asset inflation. It is not the Federal Reserve's mandate to inflate asset values, however it tends to be a consequence of their mission to support low unemployment and some stable, positive inflation. We have $6 trillion in emergency stimulus arriving shortly -- two thirds of that support is monetary policy.

mixmastamyk 7y ago

Is the sky blue? The Pope catholic? Vast money supply inflation, rock-bottom interest rates, stagnant wages, share buybacks. All accelerating over the last several decades.

gowld 7y ago

This wins today's award for least necessary question mark.

alexandercrohde 7y ago
I refuse to upvote on principle a one-liner quip on this site. But you're right, the insincere pretense of a question gives the air of a phony attempt at objectivity. Of course, that's entirely independent of whether the points are valid or not.

CrankyBear 7y ago

Conspiracy Theories R Us.

taurath 7y ago

Assets across the board are and were massively inflated because there's tons and tons of money out there any not enough investments for it.

andygcook 7y ago

There was an interesting interview with Chamath Palihapitiya on CNBC last week. Whether you like him or not, he made some good points around buy-backs and earnings per share manipulation. Worth listening to the full interview if you have 15 minutes: https://www.youtube.com/watch?v=NvEWez59fbI https://www.youtube.com/watch?v=NvEWez59fbI

snarf21 7y ago
Exactly, the Fed has artificially held rates low so companies are borrowing money for practically 0 to keep the price up and keep CEO compensation high. The only way to really fix the buyback problem is to outlaw stock based compensation for the C-suite and BOD. Then they might start focusing on long term corporate health instead of stock price and short-term quarterly numbers.

JackFr 7y ago

Issuing debt to buyback stock isn’t ‘financial engineering’ its trying to address the fundamental problem of corporate finance. You have two sources of capital, debt and equity. What is the optimal capital structure of the firm. There is no moral component as to whether a firm should be financed with debt or equity. While EPS has a smaller denominator, it also has a smaller numerator as earning will reflect the interest payments on the debt.

zuzun 7y ago

This reminds me of a paper I read in the Quantitative Finance section on arXiv.org, in which the author claimed stock markets are being manipulated by big portfolio owners, because the gains happen overnight, while the intraday returns are negative. I'm not endorsing this idea, but I consider it a fun conspiracy theory and maybe it's a good time to throw this into the discussion here. https://arxiv.org/abs/1912.01708 https://arxiv.org/abs/1912.01708

raincom 7y ago
Even if whatever this paper suggests is true, it won't contribute that much to the inflation of stocks. In this bull run, index funds have performed better than hedge funds. As long as the majority of investors (in terms of their aggregate holds) agree that the price of equities is fair, the ride will continue.

CapriciousCptl 7y ago

For a more balanced view, you can turn to JP Morgan's Guide to the Markets. It's a reliable summary of actual data so you can draw your own conclusions. https://am.jpmorgan.com/blob-gim/1383407651970/83456/MI-GTM_1Q20.pdf https://am.jpmorgan.com/blob-gim/1383407651970/83456/MI-GTM_...

rayuela 7y ago
This is an excellent deck. Thank you for sharing it!
timlangeman 7y ago
One of my main points is that you need to look beyond earnings per share to see the bigger trend. What slide/s would you use from the JP Morgan Guide that is better than the St. Louis Fed chart I featured? * https://fred.stlouisfed.org/graph/?g=qx3r The Chart on Page 7 looks fantastic but it is earnings per share, not total profits before taxes. The question I would ask is why the stock market graph looks so different than the St. Louis "Corporate profits before tax" graph? My hypothesis is that many of these companies borrowed a lot of money in the bond market to buy back their shares and thereby juice their earnings per share.
- CapriciousCptl 7y ago
  I don't understand the point you're making. Stagnant corporate profits can happen for a lot of good reasons, particularly when there's GDP growth over the same period. Increased labor pay, increased competition, cheaper and higher quality products for consumers, long-term minded growth at the expense of short-term profit taking, etc. Profit also involves some major accounting nuances. In SAAS, for instance, advertising costs resulting in customer acquisitions are generally accounted for upfront, reducing accounting profits in the period of acquisition. This is opposed to other industries, where investments are more easily capitalized and then charged over their useful life.

kakoni 7y ago

In Europe we have this thing called “covered bonds”. In scandinavia Atleast half of the housing loans are packaged into these.

LatteLazy 7y ago

The first thing you learn in accounting school is which numbers are real (revenue) and which are made up (profit).