Some argue that given the notoriously “flow-less” character of the YTD rally in equities, the V-shaped rebound off the “Christmas Eve massacre” lows can be explained in part by buybacks hitting in a low-liquidity environment.
Just as a lack of market depth can exaggerate moves on the way down, low liquidity can also lead to outsized move on the upside, as we learned late last year, when rebalancing flows catalyzed a sharp surge coming off the Christmas holiday.
“Given liquidity, it is plausible that just short covering, buybacks, dealers’ gamma hedging, and some limited releveraging drove the entire recovery [and] this, in turn, opens the possibility that the current rally can continue during the spring”, JPMorgan’s Marko Kolanovic wrote last month.
The buyback debate has now moved squarely into the political arena. It’s always been a politicized issue, but now it’s hyper-politicized, something we’ve discussed at length in these pages.
One worry is that while politicians seeking to limit or otherwise constrain buybacks might mean well, they do not fully appreciate what the market ramifications of such a move would be.
For one thing, EPS growth would invariably suffer. For instance, BofAML looked at Russell 3000 members (excluding Financials, Real Estate and Utilities) and found that “since 2013, EPS growth for this sample was 45% (8%/yr), with gross buybacks contributing 12ppt (2ppt/yr) — or roughly 30% of the EPS growth over this period”.
(BofAML)
The mechanical impact on EPS growth may actually be the least of anyone’s worries in a world where repurchases are hampered, though. As Goldman wrote several weeks ago while pondering a reality without buybacks, the removal of a real-life plunge protection/safety net could result in heightened volatility. Here’s an excerpt from our piece on that:
The really interesting part comes when David Kostin suggests that prohibiting buybacks would, quote, “lead to a greater amplitude of index moves, a wider distribution of individual stock returns, and higher volatility.”
You can be sure critics will write that off as fearmongering, but on the other hand, how many times over the past year have you heard someone say that buybacks served as literal plunge protection during 2018’s various bouts of volatility, or that things could have been worse in the absence of the corporate bid effectively putting a floor under things? Id wager you heard it on quite a few occasions, especially if you frequented these pages.
Recall, for instance, how trading activity on Goldman’s corporate desk spiked during the Vol-pocalypse. Here’s the chart from February 2018 for anyone who needs a reminder.
On Friday evening, Goldman’s Kostin took yet another look at the buyback picture and in the course of doing so, delivered an update on what’s plotted in that visual.
“While 53% of firms remain in their estimated buyback blackout windows, buyback activity has been strong to start 2019 and we expect this to continue”, he wrote, adding that “high frequency data from the Goldman Sachs Corporate Trading Desk indicate share repurchase executions have climbed 16% year/year through April 18.”
There you go. You can extrapolate from that – what do you imagine a 16% rise in flow to Goldman’s executions desk against still impaired liquidity might entail?
“Looking at sources of equity demand, we see that US companies are by far the biggest buyers, versus foreign investors and pensions/mutual funds, which were net sellers in 2018. In fact, US share buybacks reached $813bn in March 2019, an all-time high”, SocGen wrote Thursday, adding that “buybacks and scarce liquidity should continue to have a significant impact on US equities.”
(SocGen)
Goldman goes on to note that while authorizations are down 10%, there’s still some $60 billion in dry powder remaining from 2018’s authorizations (the difference between authorized and executed) and in any case, we’ve already seen $191 billion authorized in 2019.
The bottom line, from Kostin, is this:
We estimate companies will boost buybacks by 13% to $940 billion in 2019. While last year’s 54% tax-reform-assisted surge in buybacks has passed, the fundamental rationale for repurchasing shares has not changed. In June, the current economic expansion will enter its 11th year and rank as the longest expansion in US history. Capacity utilization is below average and attractive investment opportunities are limited in many industries while cash balances remain elevated and corporate earnings continue to grow. Simply put, corporate managers need to find a way to spend cash. Cash dividends will grow by 6% to $510 billion (17% of total), but will remain the less preferred method of cash return. We expect the combined cash returned to shareholders (buybacks and dividends) will rise by 10% to $1.5 trillion.
“Plunge protection” – no conspiracy theories needed.
I always seem to hear these discussions of buybacks in the context of the market as a whole. There are plenty of companies out there that are doing no buybacks, or who have made minimal purchases. I think many of those companies slumped in December, have since recovered, and are now seem overvalued.
Are there any decent studies out there comparing stock price performance by the firms that have been actively pursuing buybacks and those who have not?
I think you are missing a few fundamental points in this commentary (by the way I like your writing and often agree with you). Earnings growth has slowed and will continue to slow – and many of the S&P companies that have reported earnings thus far this quarter have mentioned that their net margins are getting squeezed either through increased labor costs or rising input costs or both (and the ridiculously high inventories that we saw in the GDP number yesterday reflecting many institutions jacking up inventories in fear of more tariffs in the trade war and now having to work off those inventories (resulting in what will be weak gdp growth the rest of the year). And the easy money has already been repatriated from offshore through the one time tax breaks they got in 2018. WIth the threat of a strong global economic slowdown (and the inevitable recession), margins getting squeezed, significantly slowing revenue growth and remaining overseas assets in the form of illiquid assets that are not easily repatriated AND the fact that many of these companies have borrowed with BBB debt to finance their repurchase plans (one of the biggest Ponzi schemes in history) coupled with the stronger democratic wave to stop buybacks and also to have some profits redistributed to the actual employees who work for the greedy people who run these big companies, The buyback party is going to morph into a a small get together soon The party is over. What happens when some of these companies cant cover the debt service on what they borrowed to buy shares back and have to start issuing new shares to cover the debt. The buyback binge is dying and will be over soon. Any responsible CFO/CEO will be keeping remaining cash in reserve to prepare for the downturn No more big buybacks coming sorry to say.
2018 buybacks were up 54% but S&P500 was down 6%. That suggests there are limits to buybacks driving the index higher.
I also like your writing Walt and enjoy your outlook and commentary. However, this is just Goldman and the other brokers talking their book. All that business – was it $800bn – this year of easy business. Mmmmm! Time to throw more money at politicians to manipulate the situation.