Buybacks Tank - Will Stocks Follow?

Thu, Aug 25, 2016 - 12:55pm

Our recent reports have worried about “short-term” stock market froth in August as indicated by options trader sentiment showing relatively heavy call buying. The additional anxiety over the contrasting US presidential candidates may also send investors and business deals to the sidelines making the fear of lower stocks and a weaker economy a reality, at least temporarily.

The new wrinkle is that Trim Tabs Investment Research indicates that corporate buybacks have suddenly plunged. We show the estimated repurchase levels below in dark blue that mirror the lowly levels of 2012. Share buybacks always rise during equity bull markets.

With paltry organic economic growth since the 2009 recovery, share buybacks become a critical source of buying power to maintain rising stock prices. When repurchases fall sharply, stock prices, in general, are more likely to fall as well.

We can theorize this drop is due to (1) anxiety over anti-business policies discussed by both Presidential candidates or (2) uncertainty over the Federal Reserve desire to raise rates making corporate debt issuance for stock buybacks more costly.

Corporate debt issuance has receded about 8% from the record 2015 levels and is still quite high. We suspect that once we get past the November 8th US presidential election, share buybacks will normalize. However, if they remain weak, then expect stock prices to be valued with far more risk.

Rate Hike?

Federal Reserve Board Presidents have been very vocal these days that strong job growth warrants raising the Fed funds rate sooner rather than later. Sure, the labor market has grown as sharply as any strong economic recovery could and “official” U3 unemployment is low, but the sluggish economy hovering just above stall speed remains a fixture.

U6 unemployment including marginal workers is well over 9%, wage inflation in this strong jobs market has remained below normal and Purchasing Managers Indices (PMI) have stalled. The composite PMI of services and manufacturing indicates a GDP that should be closer to 1% than the 2.5 to 3% many have expected during the 2nd half of 2016.

If the Fed was hesitant to raise rates all year, it’s hard to fathom how they can justify rate hikes at this juncture with these weak data points and just prior to a murky US election. Such logic has prevailed in preventing rate hikes in 2016 thus far, but there is often a lack of clarity in the messaging from our central bank.

Overbought option trader euphoria, election anxiety, and hints of a Fed rate hike should all send stocks lower short-term into September/October, but a continued dearth of corporate share repurchases could trigger a larger correction that would elevate concern of a bear market. This is still a bull market with a pause in clarity until after November 8th.

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