The Corporate Buyback Bubble

Last week the S&P500 inched up 0.37% on very light volume. Volatility, as measured by the VIX index was virtually unchanged and still hovering at historically low levels. In other words, there was very little net movement and activity in the US equity markets. In fact, as noted here before, the S&P500 has been extremely range-bound since the start of the year. Technical analysts like to point our that when markets get stuck in tight ranges for a long time, they tend to break out strongly—up or down—when the range breaks down; markets don’t exit the range with a whimper!

In other technical news, the bull market move is still in effect. Prices are above the 200 day moving average, and—critically—the 200 day average is still sloping upwards. This can be easily seen on the daily and the weekly charts. But as also mentioned last week, the distribution (or breadth) of stocks that are risking is narrowing. This means that many smaller firms are not participating in the price euphoria the way a smaller group of larger market leaders are doing.

As Wall Street roars, the real economy continues to struggle. Last week, international trade missed expectations badly; this was the biggest miss on record, and will cause the 2nd quarter GDP results to be slashed downward. PMI services also missed, as did ADP employment. Initial jobless claims beat expectations, as did ISM services. The big number of the week, payrolls, only met expectations, as did the headline unemployment rate, and the average workweek.  But average hourly earnings missed.

As the equity market keeps climbing—-and arguably into greater and greater bubble territory as defined by highly accurate historically informed measures of valuation—-a question keeps arising:  if almost everyone who wants to buy stocks, corporate and retail investors included, already owns stocks, and if the Fed has stopped printing money by ending its latest QE program several months ago, then where is the all the money to buy stocks coming from?

Well that’s simple. It’s coming from corporate buybacks, which means that US corporations—-instead of plowing more cash into capital expenditures or stock dividends—are buying their own equity shares, and thereby pushing the prices of these shares every higher.

How much are corporations spending on such buybacks, especially when compared to historical levels? That’s easy, the last time corporations bought as much of their own stock (in total dollars or as a percent of their own market capitalization) was in 2007.  And today, they have actually exceeded both these levels.

Why does that matter?  Because corporations have an awful record when it comes to buying their own shares—they almost always buy the most shares when prices are highest and they tend to sell shares (ie. raise money) when prices are super low.  And given that companies have never bought back more and given that prices have never been higher, one would be foolish not to be concerned.

Remember, just months after corporate buybacks peaked in 2007, the US stock markets began a descent that culminated in a 55% total loss, from peak to trough.

Will this time be different?

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