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Why Rising Stock Market Is Bad News     
      By   Shlomo Maital

   The New York Times reports: “The US stock market is off to its best start (of the year) since 1987”. Good news? And then the bad news….”investors are expected to dump hundreds of billions of dollars of shares this year.” Bad news.

     So what in the world is going on? The article, by Matt Phillips ,has an uncharacteristically clear, simple explanation.

     Remember that Trump tax cut? The one that put billions of dollars into the pockets of the wealthy and the corporations? Well it made the corporaitons cash flush.

     What did they do with the cash?

     Invest it, in infrastructure, R&D, innovation?

     Not exactly.

     They mostly used it to buy back their own shares, massively.

     Why? Simply – to funnel that big tax cut directly into the pockets of shareholders, at low (capital gains) tax rates.

       Share buy back by corporations drove the market up.   Even at a time when armchair investors, funds, etc…. were selling.    Investors aren’t dumb. They will take their profits, before the market crumbles when the buy backs of corporations stop.

       I avoid the stock market. But for those who want to listen, I counsel, don’t hold shares of businesses that buy back their own shares. Why? If the best investment businesses can make, is buying back their own shares, rather than developing new and better products, well —   dump them. Share buy backs are abysmal.  They are caused by CEO’s seeking to look good, in the short years they hold the position, under pressure of myopic shareholders and Boards.

         Share buy backs have now cemented corporations as the leading source of demand for shares – their own. This is a fundamental change in the way the stock market works. It is a change for the worse. When companies STOP buying back their own shares, they will pull the rug out from under the market.

     This will happen, perhaps, when the US enters recession – something most economists expect to happen by 2021.

      

 

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Record corporate profits: As usual, workers pay the price

By Shlomo  Maital   

     Corp Profits

 

The Economist’s Buttonwood column, Nov. 2,  features a striking graph (see above), showing that “American corporate profits have defied gravity” and now are at record levels, at 11 per cent of GDP, well above levels seen since 1945. 

  If things are so bad, if the US economy is so weak, why are companies making so much money? 

   Well, interest rates are low, so their finance costs are small.

   But the main reason is low wages.  Pay has not kept pace with productivity.  With a weak labor market, employers squeeze ever-higher productivity and work out of workers, terrified of losing their jobs.  But pay has not kept pace with higher productivity. So all the gains have gone to capital.  All over the world, labor’s share of national income has fallen.  Capital’s share has risen. 

    Another cause, notes Buttonwood, is share buybacks.  CEO’s get share options that ‘vest’ (i.e. can be cashed in)   in four years.  So when they take the top job, they have an interest in maximizing share prices, cashing out, and scramming.  To do this, they engage in ‘share buybacks’ – they use corporate money to buy the company’s own shares.   This is a terrible idea for the long run, because businesses should have far better things to invest in (R&D, equipment, technology, human capital) than their own shares.  But myopic shareholders love it, CEO’s love it – and the practice is widespread.  Share buybacks reduce the number of shares outstanding, raise earnings per share,  and boost profit margins.   Often companies borrow money to buy back their own shares. This is definitely NOT what the Fed had in mind, when it slashed interest rates. The idea is to get businesses to invest. Instead they use their lending to buy their own shares.    Workers, as usual, are getting ripped off.

   

Blog entries written by Prof. Shlomo Maital

Shlomo Maital
June 2019
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