Stock market safety net disappearing — with its own success to …


safety net
Stock
buybacks, historically the safety net of the stock market, are
starting to disappear.


Reuters/Mike
Segar



A strategy frequently deployed to boost share prices is on the
decline — and companies have their own success to blame.

The method in question is buybacks, in which
companies purchase their own shares. It has been a popular
technique for bolstering stock prices since the financial crisis.

Spending on buybacks, however, has slipped over the past six
months. Investment-grade-rated corporations repurchased $64
billion worth of stock in the second quarter, down from $84
billion in the fourth quarter of 2016, according to data compiled
by Bank of America Merrill Lynch.

The decline puts added pressure on the stock market, which has
become accustomed to buybacks pushing shares higher during lean
times when real fundamental catalysts aren’t present.

One of the main reasons for the decrease in repurchase spending
is an ironic one: The lofty stock prices that have helped
push the market to
record highs
are making it more expensive to conduct more
buybacks.

Earnings are also expanding at a rapid pace after several
quarters of contraction, allowing companies to grow their stock
prices through good old-fashioned strong performance.

As the BAML credit strategist Yuriy Shchuchinov put it in a
recent client note: “The reason for the decline is likely a
combination of richer equity valuations as well as better growth
globally that allows companies to deliver EPS growth without
resorting to financial engineering.”


Screen Shot 2017 09 14 at 4.55.24 PM
High-grade
issuer share buybacks are on the decline.

Bank of America Merrill Lynch

In addition to depriving shares of a reliable driver, the
slowdown in buybacks can also be interpreted by investors as
companies conceding that their stock prices are too high. It’s
the flip side of the message sent when corporations do
repurchases — that they view their shares as undervalued.

Still, the dynamic may reverse back once earnings growth starts
to slow. After all, during the SP 500’s five-quarter period
of profit contraction from 2015 into 2016, repurchases were the
market’s saving grace. The benchmark edged 1.5% higher, even
without the profit expansion usually so crucial to stock prices.

Investors probably won’t worry much for the time being,
considering indexes sit near all-time highs. The real test will
come at the first sign of downward turbulence. How will the
market respond with a weakening safety harness?

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