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    What’s Behind the Tumble of US Stocks?

    Abstract:With the coronavirus still raging across the world, the consequent global recession seems unlikely to be reversed for a while.

      With the coronavirus still raging across the world, the consequent global recession seems unlikely to be reversed for a while. While the outbreak and the previous oil price war have been the last straw triggering US stocks' slump, the root cause should be attributed to corporation's share repurchase, which had helped create the bubbles of over a decade' s bullish US stock market.

      Statistics show that since 2009, listed companies in the US have become the largest buyer of their own stocks. In buying back one's own stocks, a company can reduce outstanding shares and drive up the price per share.

      And as price goes up, current share holders will be less willing to sell, while more investors will be attracted to buy. The company may then invest the raised funds into further repurchase scheme that boosts the company's stock price.

      In usual cases, share repurchase can fuel optimism into the market by signaling that the stock is underpriced, thus increasing the stock's value and boosting capital efficiency of the company. Data from the Wallstreetcn.com shows that after financialization, some American giant companies spend 95% of the profits every year on share repurchase, investing only a small amount of money in innovation and manufacturing.

    1.png

      Repurchase of corporate stocks allows companies to quickly boost their price per share and market value; however, when considering company's state of business operation, repurchase may be risky if the company has been using borrowed money, as this would mean applying leverage on the entire stock market.

      A typical example is the Boeing Company in the US. Boeing's stock price had surged rapidly since 2016 and reached an astonishing US$441 per share at its peak, while its stock price prior to this was only US$75 per share. Behind this surge was Boeing's effort since 2016 to increase its debt level, using the borrowed money for repurchase to prop up the company's share price; but the company's state of operation had in fact been unsatisfactory, getting less than 10 billion dollars of net profit each year. This had been a potential risk factor contributing to Boeing's later slump. For the moment, Boeing's stock price has been slashed in half.

    2.png

      Recent trend of Boeing's stock price

      CEO of Bridgewater Associates Dario recently commented the market's high leverage in his article, “During the slump, the market impact on the highly leveraged companies in the most affected economies may be significant, and we will soon show you what it looks like.” Gangdrak, the CEO of Double Line Capital that was dubbed “the new bond king”, also said, “At present, the corporate leverage ratio is very high, and the size of the credit market has also increased significantly. So the corporate bond market will face tremendous troubles when the next recession come about, and we've already seen some signs of that.”

      Behind the plunge of US stocks, the market could be facing a debt crisis after the “bubble” created by high leverage bursts.

      WikiFX is a leading media in the forex industry. Visit WikiFX official website, App or Facebook page for more market updates.

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