Financial Engineering Continues In 2022

Those that have, continue to do.

In the case of corporate financial management, those that have cash or have positive cash flows continue to raise dividends.

Hannah Miao writes in the Wall Street Journal,

“Dividend payouts set another record in the second quarter, a reassuring sign to investors who have flocked to steady, income=generating stocks during the market downturn this year.”

“The companies in the S&P 500 paid out a record $140.6 billion in dividends in the most recent quarter….”

“That’s up from $137.6 billion in the first three months of the year and $123.4 billion in the same quarter last year.”

“Annual dividend payouts have notched new highs every year for a decade, excluding a slight decrease in 2020.”

Expectation: new records will be set in the third and fourth quarters of 2022 and a new historical high will be reached for the year.

Stock Buybacks Continue To Rise

Ms. Miao writes that second-quarter buybacks will set a new high of $286.4 billion.

There may be more variation in stock buybacks in the near future as corporations are reluctant to pull back dividends once they have been raised so that the most used way to vary corporate cash benefits to shareholders is to move around the stock buybacks.

Ms. Miao writes that the ratio of buybacks to dividends is currently higher than the historical average.

In all probability, this ratio should decline back toward the historical average in upcoming quarters.

Thus, with the Federal Reserve tightening up on monetary policy and the possibility of an economic recession occurring in the near future, stock buybacks should decline and the growth of dividends should moderate.

Bottom Line

For the time being, however, corporations will continue to use financial engineering to keep signals to investors as positive as possible.

If corporations are raising dividends and if corporations are buying back their common stock, the signal is that the corporations are doing OK and generating sufficient cash to share a fair portion of it with their shareholders.

If corporate cash flows begin to suffer the corporations will back off their purchase of securities. These corporations will resist cutting back on dividends as long as they can.

“Dividends are the last thing you cut.”

“You don’t want to tell the whole world you have a cash-flow problem.”

This is the modern age.

Corporate finance is the ruling focus of modern corporate management, and financial engineering is the process management uses to maximize stock prices.

What Are We Being Told?

This, to me, carries a message.

The message is that corporations are still remarkably optimistic.

We are being told that the corporate world has sufficient cash and cash flow to make it through any recession that is on the horizon and that the recession will be weak enough and short enough that these corporations will come out on the other side of the disruption, generating sufficient cash to carry on from where they are now.

In other words, to me, these corporations are signaling that any recession on the horizon is expected to be of relatively short duration and to be of relatively minor depth.

These expectations seem to be consistent with quite a few other signals being produced in financial markets at this time.

I have just discussed this point in another post.

In that post, I remarked that current market expectations in many areas seem to be consistent with the forecasts now being used by the Federal Reserve System.

That is, the Federal Open Market Committee, the policy-making body of the Federal Reserve seems to be working off of a forecast where any economic slowdown going forward will be modest and not very deep at all.

So, right now, this seems to be where many investors are, and this picture of the world dominates why markets are performing as they are.

Uncertainty

However, there is still a great deal of uncertainty in the world. This uncertainty is the underlying cause of the reason that there is so much volatility in financial markets these days.

I have gone so far as to contend that we are really in a period of radical uncertainty, a situation in which we cannot really identify all the possible paths the future might take.

And, if we cannot identify all the possible paths that the economy can take, we are forced to step back and work with vague narratives of what the future might be.

But, such a condition means that we must err on the side of caution and that we must keep close tabs on the things that are happening in markets and in the economy. In practice, this means that we tend to stick with “modest” projections of the future with the idea that we will adjust our portfolios “incrementally” as new information comes to us.

This is one reason why investors might stick with projections like those produced by the Federal Reserve rather than jumping out too dramatically into other possible narratives of the future.

However, this is a reason for the argument that the projections of the Federal Reserve will be wrong and we must be prepared for what could be in store for us.

Corporate Financial Engineering

So, for the time being, corporations will continue on with their financial engineering. This will help to maintain the confidence of the investment community, even in the face of the “not so good” incoming news.

If the Fed’s projections turn out to be correct, then the corporations will be hailed for the fact that they maintained their corporate buybacks, that they maintained their higher dividend payments, and weathered the economic disruption.

If the Fed’s projections don’t turn out to be correct, well, then, the corporations will just have to move on and reduce the amount of stock buybacks they make and keep dividends at current levels.

These corporations will then be working from a new narrative.

This is what financial engineering is all about.