A Disturbance in the Farce

Corporate revenues and earnings have been weak for quite some time. In big cap stocks this has been masked by the stock buyback effect, which supports earnings per share, even if the underlying trend of a business sucks. Unfortunately, stock buybacks are a horrible use of capital when stocks are trading at bubble valuations. Ironically, managers of listed companies have a great knack for boosting buybacks to record highs right when prices are at their peak. After a crash like the one in 2008 when prices are actually cheap, buybacks tend to dry up almost completely.

Image credit: George Lucas

Moreover, many companies are levering up their balance sheets to finance these buybacks. So not only are they buying at absurd prices, they are incurring a mountain of debt to do so. Corporate debt has rushed from one record to the next in recent years. Future regret is absolutely guaranteed.

Hitherto, the stock market has largely ignored weak earnings and so-so guidance. However, it seems the patience of investors is running out, in spite of the fact that money supply growth remains brisk and in spite of the incessantly repeated mantra of the “magical second half” in which the economy is held to finally attain “escape velocity” – whatever that is actually supposed to mean (apparently many economists believe the economy is a space-ship).

Further below is a chart showing the stocks of three companies of very different quality. The first is IBM, a company in which Warren Buffett inexplicably bought a large stake just as its stock price was close to peaking. IBM's main claim to fame is its mastery of accounting trickery, which has served it quite well while its actual business was slowly but surely going down the drain. Zerohedge recently posted an article about IBM's seemingly inexorable collapse in revenues – we reproduce the chart of its quarterly revenue growth data below: