MorningWord 11/3/15: Can’t Buyback Love

by Dan November 3, 2015 9:32 am • Commentary

This morning’s WSJ Moneybeat column had a headline I just had to dig into; Buyback Binge Looms for Stocks.  First let’s start with that word, Looms:

Nearly 25% of all annual buyback activity happens, on average, in the final two months of the year, according to Goldman Sachs Group Inc. November is typically the busiest month with companies spending 13% of their annual repurchase dollars then, the bank’s data show, which covers years 2007 through 2014, but excludes 2008 during the financial crisis. December ties with May for the third most active month with 10% of annual repurchase dollars being spent then.

The article highlights two key points about increased buyback activity in the final two months of the year. First, a lot of it occurs during weak holiday liquidity and a lack of risk taking tolerance by market participants into year end.  Second, companies feel pressure to complete their previously authorized repurchases with an added incentive to goose their stock price into year end.

In their Q2 Buyback Quarterly on Sept 21st, FactSet said that Q2 activity saw a dip:

Dollar-value share repurchases amounted to $134.4 billion over the second quarter (July), which represented a 6.9% decline from the first quarter (April) and a 0.4% decline year-over-year.

This was at a time where “Buybacks to Free Cash Flow Ratio exceeds 100% for the first time since Q3 2009”:

Companies spent more on buybacks in Q2 on a TTM basis than they generated in free cash flow (FCF). The aggregate Buybacks to FCF ratio for the S&P 500 exceeded 100% for the first time since October 2009.

And the “buyback yield hits its lowest level since April 2011”:

Companies spent more on buybacks in Q2 on a TTM basis than they generated in free cash flow (FCF). The aggregate Buybacks to FCF ratio for the S&P 500 exceeded 100% for the first time since October 2009.

The yield part is quite interesting. Especially at this stage of the game. And lately, stocks without buyback programs are outperforming. From FactSet:

Companies in the S&P 500 with no share buybacks have outperformed all quartiles of buyback yield since March 2014 on a market cap weighted cumulative return basis relative to the S&P 500 Total Return Index. This group has also outperformed the index since June 2012. As shown in the first chart on page 11, the “No Buybacks” group has significantly outperformed the benchmark return in recent months. Major contributors to this positive performance have been stocks like Google, Amazon, and Netflix, which were each up over 20% in July.

Which brings me to a post my friend Brian Kelly wrote for The TickerDistrict yesterday; Investors Don’t like Buybacks Anymore:

Since August there has been a remarkable shift in investor behavior: they no longer like buybacks. Borrowing money to buyback stock, or “financial engineering”, has been a hallmark of this bull market but investors have lost their appetite for such shenanigans. The following chart shows the Powershares Buyback Achievers ETF (PKW) vs. Powershares QQQ Trust (QQQ).

There are two key time frames to highlight in this chart. First, the massive outperformance of PKW during 2013 and most of 2014 – this was the hay-day of buybacks. Second, notice the outperformance of “tech” (as proxied by QQQ) since the August 24th lows.  For BK the takeaway is this, something changed in August – investor behavior shifted dramatically toward favoring a handful of high growth companies.

The thought process goes like this, if the Fed is ready to lift off, then you want to be invested in companies who have been investing in themselves (R&D, building infrastructure and hiring) as opposed to those who have been spending all of their free cash flow to manage earnings. Because that buyback wind at their backs won’t be there anymore. It looks like investors are getting ahead of this.

I would add one last point, whether a surge in buyback activity helps the S&P500 (SPX) close at the highs or not, it does not change the fact that the Fed is either going to usher our economy into a higher interest rate environment in 2016, or they will be unable to, due to the state of global growth. Ether way, it doesn’t seem like an opportune time to commit new capital to equities. Just sayin’.