The math on the buybacks is simple. Let’s say a company earns $100 million annually and has 50 million shares outstanding, so it has earnings of $2.00 per share. Also assume the stock trades at $25, or 12.5 times earnings. If the company has cash reserves it can use those for the buyback but let’s assume instead that the company borrows $200 million and uses that money to buy back its own stock. The annual interest rate on the loan will cost the company $4 million, reducing the annual earnings to $96 million. However the share count will also be reduced to 42 million following the buyback so the earnings per share rises to $96/42 or $2.28 per share, 14% above the prior year. Investors generally pay a higher earnings multiple for this higher growth so we can assume that the multiple on the stock will rise from 12.5 to 15. Applying that 15 multiple to the $2.28 in earnings gives a price $34.20, an impressive 36.8% above the prior level of $25. Not bad for a transaction that did nothing to improve growth, solidify the balance sheet or allow for expansion. Look closely at the earnings and multiple path of Home Depot stock (just one of many examples) over the past few years and you can see how the earnings multiple has expanded as share buybacks have enhanced earnings growth. More importantly, while corporate boards are authorizing their companies to engage in these activities which have no other goal outside of supporting the stock price, these corporate insiders themselves are selling their own holdings of stocks at the highest rate since the financial crisis. It’s hard to see this situation as anything but pure ‘financial engineering.’ Yet, with the S&P 500 trading near its highest price/earnings ratio in 40 years, excluding the dot-com bubble, companies in the index are set to buy back $604 billion of shares this year. That’s up 18% from last year’s buyback expenditures, and a 313% increase from 2009. Corporate spending on research and development, in contrast, has risen less than 50% in the past six years.

Companies have not had great timing with these purchases either. In 2007, S&P 500 firms allocated more than one-third of their cash use ($637 billion) to buybacks just before S&P 500 plunged 56%. Conversely, at the bottom of the market in 2009, firms devoted just 13 percent of their annual cash spending to repurchases ($146 billion). U.S. companies announced $141 billion of new stock buyback programs in April, the highest level ever for new buyback programs during a single month and an increase of 121% from April 2014. The rise now puts 2015 on pace to reach $1.2 trillion worth of announced buyback programs, shattering the 2007 record of $863 billion in authorized buybacks. Stock buybacks have been widely cited as giving fuel to the bull market in stocks, now in its sixth year.

In many ways isn’t this what central banks and governments are doing as well? The record low level of global interest rates has only succeeded in driving up the prices of financial assets such as stocks and bonds, but has really done little to stimulate economic growth. Six years into this ‘zero interest rate experiment,’ U.S. growth is muddling along at a 2.5% rate, European growth has climbed to a meagre 1.5% and China has slowed down to its lowest growth rate since the last recession. Meanwhile, these central banks have ratcheted up the debt on their balance sheets. At some point all of this liquidity will start to fuel some inflationary pressures, perhaps more from a lack of new industrial supply capacity than because of growth in demand. At that time the central banks will have to begin reversing these zero rate policies and move interest rates higher. We might be seeing the early signs of that already as U.S. and German bond yields have started moving higher in the pat two months despite the lack of growth. Markets will ultimately do what the central banks are unwilling to do.

One of the biggest calls on the direction of financial markets is getting the direction of the U.S. dollar right. The trade-weighted value of the U.S. dollar (referred to as the DXY and shown in the chart below) rallied more than 35% from the 2011 low of under 73 to the recent high of over 100. This has proven as one of the key headwinds for commodities as they are all priced in U.S. dollars. The reason for the strength in the US$ is simple; while most central banks continue to advocate zero-interest rate policies, the U.S. Federal Reserve has completed its Quantitative Easing programs and has indicated that its next move is to take interest rates higher. While the timing of that first interest rate is the only thing that remains in doubt, the implied direction has lead to a huge flow of international money into the U.S. dollar to capture these higher rates. The U.S. dollar has also been increasingly seen as a safe store of value in volatile times over the past number of years, replacing gold in that regard due to better liquidity and a positive level of income associated with owning U.S. Treasury securities.

Trade Weighted Value of the U.S. Dollar

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