Dow 20,000 Obscures Eroding Technicals

Share buybacks, market meth since the financial crisis, have cratered. Wolf Richter highlights just how far corporate America has pulled in its horns:

Share buybacks in the third quarter plunged 28% year-over-year, to $115.6 billion, the biggest year-over-year dive since Q3 2009, according to FactSet. It was the second quarter in a row of declines, from the glorious Q1 this year, when buybacks had reached $168 billion, behind only Q3 2007 before it all came apart.

From that great Q1 2016 to Q3, buybacks plunged 31%, or by $52 billion.

“Only” 362 of the S&P 500 companies bought back shares in Q3, the second lowest number in three years, with Q2 having been the lowest number (blue line in the chart below).

However, the third quarter has historically produced the most buybacks as companies are feverishly trying to put some lip gloss on their annual earnings per share. But not this time.

Share buybacks can be seriously value-destructive, since companies, especially buyback titans in the tech sector like Apple and Microsoft, risk buying shares at prices that are overvalued because of technicals – specifically, shrinking floats – rather than fundamentals.

Several things could be driving this.

Companies might have simply realized that their valuations are not justified by their earnings growth, and so leveraging themselves to the gills to purchase shares has become increasingly bad policy. Since management compensation is typically tied to the earnings per share growth that buybacks goose, this seems unlikely – it would run against human (or at least C-Suite) nature.

Management may be girding for tougher times ahead, protecting their cash flows from rising rates.

Management might have one eye on Trump’s plan to provide a tax “holiday” to allow them to repatriate their overseas cash without paying the full corporate tax on it, and once that happens, they may fire up the buyback machines again.

Nonetheless, the buyback stats – especially given that they fly in the face of management incentives – should be sobering for those who see Dow 20,000 as merely another signpost on the relentless upward march of share valuations.

Even with the buybacks, the S&P 500’s earnings per share has fallen sharply since hitting its historic high of 107.61 in September 2014. It was 87.17 at mid-year 2016, a level not seen since February 2011, according to multipl.com.

Along with investors who could soon endure unpleasant mean reversions in their stock portfolios, the valuation boom has been bad for start-ups trying to get out of the gate. The amount raised via IPOs has fallen sharply in the last two years. Again, from Richter:

Last year, the number of US-listed IPOs had plunged 38% to 170, according to Renaissance Capital. In terms of dollars, only $28.7 billion was raised, down 48% from 2014. By that measure, according to Thomson Reuters, it was the “worst year since 2009.”

But that’s like so 2015.

In 2016, only $24 billion was raised in US-listed IPOs, according to Dealogic – the worst year since 2003. Even during the Financial Crisis, IPOs raised more money than in 2016: $30 billion in 2008 and $27 billion in 2009.

He considers that this may be due, in part, to the outsized valuations of start-ups, and the unfortunate habit that “unicorns” – start-ups with valuations over $1 billion – have of imploding.

Technicals might trump (sorry…) fundamentals for a while longer, but given the new administration’s apparent glee in creating uncertainty, it seems a bad long-term bet. If Trump pushes through a capital gains tax cut, vertiginous investors might reach for their ripcords.

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s