Behind the Levitation

Last week when I commented on the downward revision of the already weak First Quarter GDP numbers, several commenters wrote in to ask: what is keeping the stock market so high?  Great question, with the best answer being ZIRP, the Federal Reserve’s “zero interest rate policy,” now matched by many other central banks (with some actually now employing negative interest rates).  I’ll leave for another time whether the risk of deflation is such as to warrant ZIRP.  It has always been true, however, that times of loose money tend to send stock prices higher than intrinsic valuation might warrant, as the money has nowhere else to go to get plausible returns.

But take note of two items in today’s Wall Street Journal.  The first concerns those very same central bankers who now say financial markets are out of step with the real economy:

BRUSSELS—Buoyant financial markets are out of sync with the shaky global economic and geopolitical outlook, the Bank for International Settlements said in its annual report published Sunday.

The warning from the BIS, a consortium of the world’s top central banks, comes as financial markets from stocks to bonds to commodities have been enjoying a broad-based rally in the first half of 2014, reflecting investor optimism over expansionary central-bank monetary policies.

“Overall, it is hard to avoid the sense of a puzzling disconnect between the markets’ buoyancy and underlying economic developments globally,” the report read.

But it is a second story that really caught my eye:

Stock Advances Are an Inside Job

Quick, what is the stock market’s biggest driver today?

Corporate earnings? Interest rates? The Federal Reserve? Some say the correct answer is something people rarely discuss: companies buying back their own stock.

Companies purchasing their own shares represent the single biggest category of stock buyers today, according to a study this month by Jeffrey Kleintop, chief market strategist at brokerage firm LPL Financial.

Only one other major group, individuals, is a net stock buyer now and individuals are buying less than corporations, Mr. Kleintop found. Of six major groups he identified, hedge funds, foreigners, insiders and investment institutions such as pension funds and insurance companies all are net sellers, he found. . .

The pullback by traditional investors helps explain why stocks have had trouble making progress at various points this year, money managers say. And the increasing prominence of corporate buybacks has drawn criticism from some in the investment world.

“Most of the buying is coming from the companies themselves. It doesn’t sound healthy but that is certainly where it is coming from,” Mr. Kleintop said.

Hmmm.  Assuming a well-managed company with a decent internal rate of return (always a somewhat tricky calculation), buying up your own stock in a world of ZIRP may make perfect economic and business sense.  But one also thinks of a  term beginning with the letter “B.”

Recommend this Power Line article to your Facebook friends.

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