In recent days we have witnessed a massive outflow from virtually all holders of stocks. Just last week we reported that retail had just dumped the most stocks in the past 5 weeks since the August 2011 US downgrade...
... confirming a long-running trend observed with BofA smart money clients who, as we also reported last week, have sold stocks for 15 of the past 15 weeks, the longest selling stretch on record.
This has repeatedly prompted many to wonder who is buying.
The one recurring answer (assuming it is not the BOJ buying the SPY directly or the NY Fed instrucing Citadel to intervene in the market at key inflection points) is corporate stock buybacks. Recall, that as Goldman pointed out a month ago, "buybacks will remain the key source of equity inflow in 2016" adding that "corporations will purchase $450 billion of US equities in 2016 and will remain the largest source of US equity demand."
However, that one particular bullish outlook on the only real buyers in the stock market, i.e., corporations repurchasing their own shares, may be in jeopardy, because as it turns out, after snapping up trillions of dollars of their own stock in a five-year shopping binge that dwarfed every other buyer, U.S. companies from Apple Inc. to IBM Corp. just put on the brakes. Bloomberg cites research by Birinyi Associates according to which announced repurchases dropped 38 percent to $244 billion in the last four months, the biggest decline since 2009.
As Bloomberg adds, planned buybacks among American firms tumbled from a year ago by $147 billion, an amount equal to 2.5 times the profit S&P 500 companies lost in the 12 months through March. Needless to say this is a big hit to S&P EPS where buybacks have traditionally provided a substantial boost to the declining denominator while the numerator has been steadily shrinking over the past several years alongside the biggest unspoken secret on Wall Street, namely shrinking cash flows and sliding profits.
This is troubling because coming amid the worst profit slump since the financial crisis, the buyback slowdown, long the only source of support for the stock market, may signal companies are preserving cash as economic and political uncertainty whips up from Europe to China and in the U.S. At stake is the primary source of buoyancy for the second-longest bull market in history, at a time when individuals and money managers are bailing out and valuations sit near 14-year highs.
Traders are worried: "If the only meaningful source of demand in the market is companies buying their own shares back, then what happens if that goes away?” said Brad McMillan, chief investment officer of Commonwealth Financial Network in Waltham, Massachusetts, which oversees $100 billion. “We should be concerned.”
In addition to buybacks, companies are also slashing dividend payments. "As profits fell for a fourth straight quarter, the number of firms slashing dividends rose to a seven-year high. Executives are scaling back after handing out sums of cash that exceeded their earnings, an act that has drawn criticism from politicians. Presidential candidate Hillary Clinton said in July that companies’ focus on share prices is hurting the economy because it lowers investment."
Some are urgently trying to justify the collapse in buybacks:
The first-quarter slowdown was mostly executives responding to the economic and credit stress earlier in the year, according to Joseph Amato, chief investment officer of equities at Neuberger Berman LLC in New York, where the firm oversees $243 billion. As the fear subsides, buybacks are likely to stay elevated, he said.
“The scare in the first quarter was overblown,” Amato said. “The economy is growing on the global basis at a reasonable level. That, in our mind, would suggest that companies will come back and have a typical buyback program consistent with levels of the last few years.”
To be sure, a sudden surge in debt issuance in recent weeks on the heels of the ECB's backstop fo European and thus global Investment Grade bonds may unlock the next big rounds of buybacks. The likelihood that companies will increase spending as the year progresses was highlighted in a May 12 note from David Kostin, the chief equity strategist for Goldman Sachs Group Inc., who predicted that repurchases will increase 7% in 2016 and remain the primary source of U.S. stock demand.
The problem is if repurchases do not rebound. Announced buybacks are blueprints that cover strategies for two or three years and hence loosely correlate to the amount of repurchases that are executed, with actual buying equaling 81 percent of authorized since 1985. Should the ratio hold and the pace of announced buybacks keep through December, repurchases would fall below $600 billion for the first time in three years. Buybacks hit a record $762 billion in 2007.
The worst case scenario is if companies, already encumbered with record leverage, are simply unable to issue any more debt, whose proceeds would normally be used to fund repurchases. it would also mean that management teams are increasingly bearish on growth prospects.
"Pulling back on buybacks is company management telling us they are either not optimistic or more pessimistic than they were in the past and they’re doing it through their actions,” said Joseph Veranth, chief investment officer at Dana Investment Advisors in Brookfield, Wisconsin, which manages $7 billion. “It may be a harbinger of a weaker outlook on behalf of management for company prospects going forward.”
Adding insult to injury, the buyback slowdown takes place when the potency of buybacks is waning. After beating the market by at annualized pace of 3.5 percentage points in the four years through March 2015, the S&P 500 Buyback Index that tracks stocks with the highest payout ratio has since trailed the broad measure by almost 10 percentage points. CFOs are certainly aware of the fact that the market is increasingly punishing companies that buyback at the micro level, even if it rewards the overall market at the macro.
The conclusion, as summarized by Bloomberg, is that a weakening in corporate demand could tilt the market’s supply and demand balance in favor of bears. U.S. firms have been the biggest buyer of stocks every year since 2009, with their net purchases exceeding $2 trillion. Their role in keeping the bull market afloat is more pronounced this year. According to Bank of America Corp., the firm’s trading clients from hedge funds to wealthy individuals were net seller of stocks for 15 straight weeks through May 6, a record streak. The only buyer was corporations scooping up their own shares.
“Companies have been a fairly consistent buyer that has supported the late stage of this bull market,” Channing Smith, a managing director at Capital Advisors Inc. in Tulsa, Oklahoma, said by phone. The firm oversees about $1.6 billion. Their potential retreat means “there is less firepower to counter any type of bout of selling,” he said.
Maybe there is hope in corporate earnings? Alas, no. As we showed yesterday, following an abysmal Q1 earnings season, Q2 is already shaping up as the 5th consecutive quarter in which Y/Y EPS are poised to drop. A streak that long has not happened since the financial crisis.
Finally, recall that while non-GAAP earnings are down sharply, non-GAAP profits - a proxy for true profit margins and cash flow - has collapsed. As we showed just last night, the spread between GAAP and non-GAAP earnings is now the widest it has been since 2008.
If, indeed, buybacks are now also off the table, then central banks - beyond merely the BOJ and SNB who already do that on a day to day basis - will have no choice but to directly step in and monetize not just bonds (and perhaps commodities) but also stocks. At that point, the case on whether there is a "market" or merely a "monetary policy tool" will finally be closed.