Thursday, August 17, 2006

The Stock Market is Going Up... uh, Right?- Part 2

I mentioned previously the importance of critical thinking. Today we have Exhibit A from one of the very best newspapers in the known universe.

In this morning's Heard on the Street column, Gregory Zuckerman lays out a case for higher stock prices based on a recent "borrowing binge" by US corporations.

...the [increased borrowing] could help the stock market deal with an expected slowdown in profit gains later this year as the economy contracts. That is because both higher dividends, and buybacks that raise earnings per share by reducing the number of outstanding shares, could help offset any decline in profit growth.

The rate of increase in debt is certainly a concern, and the use of those funds by some companies trying to goose their stock prices is troubling, but to jump to a conclusion that as a result the stock market will go up is... ludicrous. The total market cap here in the US is enormous compared to even the most generous projections of new debt being issued- even if we were to assume that every new dollar of debt was dumped into the market.

Analysts and investors are compiling lists of companies with relatively clean balance sheets and steady cash flows that could find themselves attractive as leveraged-buyout candidates, which depend on adding debt to a target's balance sheet.

The author also stumbles into a sorta semi-related point that has received a fair amount of attention recently: the surge in private equity funds taking public companies private. Several potential targets are named, and several experts are cited adding fuel to the fire.

But like any journalist with two good hands ("on the other hand..."), we are reminded none of this may happen.

The rosy debt scenario is predicated on an economy that doesn't weaken significantly, and on interest rates not climbing much higher, both of which would make the increased debts more of a burden. It all comes at a time when individuals and the U.S. government are dealing with their own heavy borrowing, making it more important for U.S. companies to successfully handle their added debt.

It's fun to ramble on about takeover candidates, and if you throw enough examples out there you're liable to look smart when one of them gets taken out. But what of the giant pink elephant in the room totally ignored in this piece?

The "wave of leveraged buyouts" is mostly due to the easy credit (razor thin credit spreads) sloshing around the system, much of which is making its way to PE funds and the like. And why are they so interested in buying up everything in sight when everybody and his brother seems to realize the economy is slowing down? Well, that is largely due to their understanding that the credit spigot will be shut off if the current trends in the economy persist-- especially if those unwelcome trends accelerate.

Finally, what does this say about today's investors, and the companies they invest in, when there is apparently "pressure from shareholders for larger dividends and share buybacks", without a care in the world about the consequences?


Anonymous Market Participant said...

It says they are fearless and greedy. On Wall Street: fear varies, greed is constant.

10:27 PM  

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