Authored by Lance Roberts via RealInvestmentAdvice.com,
On May 24, 2018, Paul La Monica penned an article for CNN Money entitled Companies have spent a stunning $2 trillion on mergers so far this year. The article notes that in 2018 merger activity has hit a feverish pitch fueled by “healthy balance sheets and strong share prices.” While somewhat true we think it is important to tell the whole story.
We have written numerous articles describing how cheap money and poorly designed executive compensation packages encourage corporate actions that may not be in the best interest of longer-term shareholders or the economy. The bottom line in the series of articles is that corporations, in particular shareholders and executives, are willing to forego longer term investment for future growth opportunities in exchange for the personal benefits of short-term share price appreciation. Buybacks and mergers, both of which are fueled by the Federal Reserve’s ultra-low interest rate policy have made these actions much easier to accomplish.
On the other hand, corporate apologists argue that buybacks are simply a return of capital to shareholders, just like dividends. There is nothing more to them. Instead of elaborating about the longer term ill-effects associated with buybacks or the true short-term motivations behind many mergers, the powerful simplicity of the following two graphs stands on their own.
The first graph, courtesy Meritocracy, shows how mergers tend to run in cycles. Like clockwork, merger activity tends to peak before recessions. Not surprisingly, the peaks tend to occur after the Federal Reserve (Fed) has initiated a rate hike cycle. The graph only goes through 2015, but consider there has been $2 trillion in mergers in 2018, and its only June.
The following graph shows how corporate borrowing has accelerated over the last eight years on the back of lower interest rates. Currently, corporate debt to GDP stands at levels that accompanied the prior three recessions.
There is a pattern here among corporate activities which seems similar to that which we see in investors. At the point in time when investors should be getting cautious and defensive as markets become stretched, they carelessly reach for more return. Based on the charts above, corporate executives do the same thing. The difference is that when an investor is careless, his or her net worth is at risk. A corporate executive on the other hand, loses nothing and simply walks away and frequently with a golden parachute.
Being a good steward of wealth is most difficult when everyone else is chasing the bubble. Corporate executives are no exception. Their actions may seem harmless as the economy is growing and the market steadily rises, but the last two recessions demonstrate that the wreckage of poor corporate decision-making falls mostly on workers and investors in the guilty companies. This time will be no different; the only question is how much higher does the Fed need to boost interest rates before the consequences of their actions become obvious?
Just something to think about as you catch up on your weekend reading list.
Economy & Fed
Most Read On RIA
Research / Interesting Reads
“ The stock market is the story of cycles and of the human behavior that is responsible for overreactions in both directions.” – Seth Klarman
The post Weekend Reading: Merger Mania appeared first on crude-oil.news.