Goldman Sachs just completed an analysis of corporate balance sheets and found that dividend and stock buybacks accounted for 103.8% of their free cash flow. Meaning that they were paying more out in cash than they had on hand! Over the last year, free cash flow has dropped 15 %, while debt is up 8 %.
This corporate balance sheet squeeze is unprecedented; it is the worst cash flow crisis since 1980 and is unsustainable. Corporate executives have turned to excessive borrowing levels to keep this financial merry-go-round going. A good amount of this debt is used for stock buybacks to hype share prices and keep earnings per share higher than they would be without buybacks.
If sales and profits drop due to the trade war and/or consumer spending declines as it has in the last four months, some corporations will default on their debt. A downward economic spiral can be triggered.
Maybe this is another reason the Fed announced a cut in interest rates and a shift to an ‘inflation averaging framework.’ JPMorgan recently commented in Marketwatch that they believe Fed economists are shifting to a position of not worrying about inflation but instead on keeping money flowing to corporations at low interest rates possibly as low as zero in the future.
By keeping rates extraordinarily low, the Fed enables executives to waste profits on stock buybacks to increase their stock-based compensation and further increase stock prices. If we want strong, durable, and sustainable economic growth, then we need strong companies making investments in research, development, innovation, productivity improvements, employee training, and raising wages. When the economy works for all democracy is strengthened.
The financial music will stop when sales and profits decline and an already desperate cash flow position becomes untenable, putting many companies viability in doubt. Looking out a year or two, we expect the Fed to come to the rescue after possible zero interest rates have panned out. Last March, former Fed Chair, Janet Yellen recommended that the Fed be authorized to purchase corporate stock and bonds to keep the economy going if a recession hits.