Daily Archives: August 21, 2014

Buttonwood -Caught out- The Economist

This can be sign to come

In a sense, stock markets have defied gravity. Central banks slashed interest rates (and introduced quantitative easing) because they feared the economy would be weak; the economy has indeed been weak. But profits have been strong. As the chart shows, American profits rebounded quickly from their collapse in late 2008. They are close to a post-war high as a proportion of GDP, even though they fell slightly in the first quarter.

The main factor has been an increase in margins; sales per share are barely higher than they were six years ago. The sluggish performance of real wages has kept costs down. But another factor has been companies’ use of their spare cash to buy back their stock. This makes earnings per share rise faster. American firms announced buy-backs worth $671 billion last year, or about 3.9% of GDP, and have made plans for nearly $300 billion this year, according to TrimTabs, a data service. That is more than four times the money placed into equity funds by retail and institutional investors.

Like a snake swallowing its own tail, the corporate sector is absorbing its own equity. How long this can continue is anyone’s guess. The peak year for share buy-backs was 2007, just before the debt crisis. That is not a great omen.