You might have noticed the similar pattern in U.S. equity returns for the months of January and February over the last two years. Last January the S&P 500 (SPX) saw a fairly sharp drop of 3.6% only to have all that and more made up by February’s 4.3% gains:
And in 2015, we saw the S&P 500 drop 3.2%, only to have those losses eclipsed by February’s eye-popping 5.5% gains:
Some may find this pattern curious, but I assure you there is nothing particularly sinister going on here, especially if you don’t find year end portfolio marking a problem. Obviously, portfolio managers get paid on performance with tremendous pressure to outperform benchmarks. Because of that they have every incentive to have their holdings close at the highest levels possible at the end of each reporting period, with none more important than year end. PMs gun their holdings into year end, and look to lighten up on their increased holdings early in the new year. The problem with doing this in January is that we get a good chunk of Q4 S&P 500 earnings mid month, and companies have to suspend their share repurchase activities in and around their earnings reports. So we have a situation where there are motivated sellers lacking a huge natural buyer of stocks that have been pillars of the bull market. So in some ways, that can explain a little about the last couple Januaries…..
There were $118 billion in buyback authorizations last month, eclipsing the $117 billion in February 2013, according to Birinyi Associates.
Natural sellers looking to trim their shares from their late year window dressing buying in January at a time where corporate buy-backs are weak due to regulations followed by a buy-back bonanza after black-out periods as company’s look to execute (manage) to their most recent earnings projections for the current period or balance of the year.
As I highlighted last week in this space (read here), some huge market leaders like The Home Depot (HD) would be hard-pressed to maintain double digit earnings growth without their aggressive buybacks funded by debt:
HD has been active in balance sheet management resulting in in earnings growth well above the S&P 500 average. In late 2013, the company got even more aggressive in their share buybacks,accelerating to the tune of $3 billion in December 2013 and then again in early June the company issued $2 billion in debt to buy back even more stock.
But here is the thing, the current year guidance suggests a fairly large earnings growth deceleration (22% to 14%), and as stated above that includes retiring 3% of their shares outstanding, less obviously if the stock continues to move higher.
So the company just added $18 billion to their share buyback authorization, and why shouldn’t they given the ease of money and the lack of revenue growth. But I will add one thing. As investors contemplate the potential adverse affects of higher rates, I would suggest one of the first casualties could be debt fueled buybacks, and the price action of the last couple January’s could be a precursor of whats to come if a massive natural buyer throughout the bull market were to scale back activities.