A Ticking Time Bomb for Today's Bull Market

Steve's note: Regular readers know I'm bullish on U.S. stocks in the near term. But the long-term picture will get ugly. And while you want to invest for the upside, you need a plan for what comes next. Today, my colleague Mike DiBiase continues his two-part series on one reason we're inching closer to a market peak...

Yesterday in DailyWealth, I showed you a powerful, lesser-known tailwind that's been driving this decadelong bull market.

I'm talking about share buybacks. As buybacks have grown in popularity, they have stoked demand for stocks and propelled prices to incredible heights... even though most of them are performed for the benefit of high-level executives, not shareholders.

That's not to say you should avoid every company that buys back its own shares (although I will show you a few stocks that you should absolutely steer clear of today).

But for the sake of your financial future, you do need to know one important thing...

This trend is unsustainable. And when it collapses, this bull market will lose one of its biggest driving forces.

Let me explain why, starting with some more key aspects of how buybacks work...

Not all buybacks are fundamentally bad. In fact, we can tell whether a particular buyback is a good or bad investment for a company...

First, consider that companies can finance buybacks in one of two ways: They can use the excess cash on their balance sheets, or they can borrow the money.

Using their own cash is by far the better choice. But even doing that can be a bad decision. When a company buys back its shares with its own cash, it's electing to return the cash to shareholders instead of investing it elsewhere.

This suggests that the company has nothing better to do with that money... like investing in research and development or new long-term projects, buying other companies or technologies that will help it grow in the future, or paying down debt.

You get the point. A company can make much better investments with its cash than buying back its own stock.

Here's the other part of the equation to consider...

Usually, buying back shares only makes sense when a company's stock is cheap. That's one of the problems we're seeing with today's bull market...

The reality is, most executives buy back their own shares at the worst possible times.

The following chart compares the value of the S&P 500 Index with stock buybacks of the companies in the S&P 500 since 2002. You can clearly see that companies buy back the most shares at market peaks, when stock prices are most expensive. They did it in 2007, and they're doing it again today – with even greater intensity...

You can also see that buybacks have been on a tear since the end of the last financial crisis. They've increased nearly every year since 2009.

This tailwind has been the hidden driver behind the current bull market... But if you weren't paying attention, you might not have even realized it.

Last year, U.S. companies set a record with more than $800 billion in share buybacks, shattering the previous record of nearly $600 billion.

Companies also spent more on buybacks last year than they spent on capital expenditures for the first time since 2007. In other words, instead of investing more in capital projects that will benefit shareholders in the future, corporate executives are using buybacks to make themselves richer.

But buying back shares when they're expensive isn't corporate America's worst offense...

The worst offense is buying them back using debt.

Some companies, like iPhone maker Apple (AAPL), have loads of excess cash to buy back shares. But most don't... And borrowing money to do so can turn a bad investment decision into a disastrous one.

The table below shows some of the biggest offenders of the past five years – seven of the companies that have bought back the most shares using debt...

Stay away from these companies – and any company that uses debt to buy back shares, for that matter. It's almost never a good investment.

These companies are exchanging their valuable equity for debt. Remaining shareholders are left owning a more indebted company.

Worse, this trend adds up to a ticking time bomb for today's bull market. Remember how the subprime mortgage crisis ended when people levered up by borrowing against the equity in their homes?

Companies today are essentially doing the same thing. They're levering up their balance sheets like private-equity corporate raiders... Only instead of buying other companies with debt, they're buying themselves.

This can't continue forever...

Many companies have seen their debt loads grow to unsustainable levels. Taking on more debt will put them in danger of going broke.

Corporate debt in the U.S. now totals nearly $10 trillion, the highest it has ever been. As you can see in the following chart, it's up more than 60% from the end of the last financial crisis...

Measured against our gross domestic product (GDP), corporate debt is the highest it has ever been at 47%.

And it's not just the amount of corporate debt that's concerning... It's also the quality. Today, $3 trillion of debt is rated at the lowest level of investment-grade debt – by far the most compared with any other time in history. These companies are teetering on the edge of becoming junk. By taking on more debt to buy back their own stock, they risk a credit rating downgrade and much higher interest costs.

Not only that, but the cost of debt is increasing, too. After a decade of artificially low interest rates, rates are on the rise once again, making debt-funded buybacks more expensive. Many companies are bloated with debt and can barely afford to pay the interest today.

For now, buybacks will continue to propel the market forward. Companies spent roughly $200 billion in the first quarter this year.

But the end is near. The large spike to $800 billion last year was partly due to the new tax law that gave companies incentives to bring overseas cash back to the U.S.

I expect we'll see buybacks decrease this year for the first time since 2009. As the pace of buybacks slows, one of the biggest forces behind this bull market will disappear... And that could lead to the end of the longest bull market in history.

Good investing,

Mike DiBiase

Editor's note: While stocks still have plenty of profit potential, you need to make sure to protect your downside – before the crash. That's why Porter Stansberry and investing legend Jim Rogers are hosting an urgent online event on Wednesday, May 15. Tune in for free, and you'll learn the steps you can take right now to weather the storm... and even make money. Get more details here.

Further Reading

"Every Melt Up ends the same way... with a 'Melt Down,'" Steve writes. Learn more about this key takeaway from his first Melt Up – and how you can plan for the inevitable downturn – right here.

"I believe the recent downturn showed us something important," Dr. David Eifrig says. "Now is the time to get defensive." The right investments are crucial during a bear market. Read more about his favorite types here: A Lesson in Income Investing at the Grocery Store.

Market Notes

Today, we’re revisiting a leader in one of our favorite technological trends…

Longtime DailyWealth readers know that Steve believes we’re moving toward a time when no one will carry cash. This trend is already well underway in countries like China and Sweden… And it’s beginning to gain traction here in America. Today’s company is a leader in this global trend…

Global Payments (GPN) is a $23 billion provider of digital-payments software. Its software allows merchants to securely and easily accept credit and debit cards, along with other payment methods. This helps businesses run more efficiently… and lets them expand quickly to new areas. In its latest quarterly earnings, Global Payments reported revenue of $883 million, an 11% jump from the same period in 2018. That’s the digital-payments trend at work…

As you can see in today’s chart, shares of GPN are soaring so far in 2019. The stock is up more than 50% since bottoming on December 24, and it recently hit a new all-time high. As long as people keep ditching their cash worldwide, this stock should continue higher…