MorningWord 2/3/15: Buyback Machines

by Dan February 3, 2015 9:28 am • Commentary

There has been a lot of talk over the last few days about the poor start for U.S. stocks in 2015, and what it means for the balance of the year.  On Friday in this space (MorningWord 1/30/15: That’s the way it goes, but don’t forget it goes the other way too) I offered my pearls of wisdom on what January’s 3% decline in the S&P500 means for your portfolio going forward, in sum: NOTHING. Here was a quick rundown of some recent history of the January Barometer:

We had monster January returns in 2011, 2012 and 2013 of 2.27%, 4.25% and 5% respectively with the S&P closing flat in 2011, up 13% in 2012, and up 30% in 2013. The S&P 500 declined 3.43% in January 2014, before closing up more than 11%.  And in 2010, the S&P 500 closed down 3.82% in January, with the index closing up about 12% on the year.

One reason for the weak January performance in equities could be the lack of share-buyback activity to start the year. This follows a record close in the S&P500 (SPX) in 2014 straight into an earnings season where many companies have to suspend their repurchase activity as they enter into “quiet periods”, as the WSJ MoneyBeat blog re-iterated this morning:

January is historically the slowest month for overall buyback announcements based on data from Birinyi Associates going back to 1999.

The January weakness off of the highs makes sense with that in mind, given the importance of share-buybacks helping to power gains in U.S. stocks in a low rate environment.  But the post quickly goes on to say:

But this January was different. According to Goldman, its buyback desk saw a roughly 60% rise in spending and authorizations in January from the same time a year ago.

Last month’s strength precedes what is typically the busiest month for buyback authorizations: February. According to Birinyi, an average $46 billion in overall repurchases have been announced in February over the past 15 years.

So is it a shock that February got off to such a strong start yesterday as portfolio managers shift allocations and some large corporates getting back in the mix?

So what’s it all mean?  It’s really hard to arrive at broad strategies to take advantage of such activity aside from understanding that share repurchase activity will continue to be a massive tailwind for the stock market (as long as it lasts). Goldman predicts:

2015 will be another strong year with S&P components shelling out $604 billion in executed buybacks – a 12% gain from the prior year

But it is important to note the lack of participation by some sectors like banks stocks during and after the financial crisis and energy companies now. Troubled sectors have the potential to drag down S&P earnings growth (CVX and XOM both in the last week announced cutbacks to their buyback plans for 2015, and both huge contributors to S&P 500 earnings). Remember that when companies buy back shares they are taking them off of the public market, and thus reducing the share count. EPS (earnings per share) goes higher when the earnings number is divided by a lower share count.  Remember though, it goes the other way too.  If the hope that share buyback activity will be replaced in a strengthening economy by organic eps growth, not manufactured, isn’t realized, things can get ugly. In scenarios like the financial crisis, or the recent commodity collapse, the sudden lack of buyback activity can exacerbate a fundamental earnings decline.

And this scenario puts greater pressure on companies like Apple which will be a massive contributor to S&P earnings growth in 2015, and has a history of aggressively buying back stock (last late Jan/ early Feb AAPL bought $14 billion in an accelerated buyback).  Again placing greater emphasis a large market leaders who have been doing a lot of heavy lifting for the broad market of late.