According to the American Prospect, a progressive policy journal, U.S. companies in the S&P 500 spent $5.3 trillion on buybacks between 2010 and 2020. Some analysts believe corporate buying power was responsible for 40% of the rise in stocks over that period, a huge contributing factor to the Great Bull Market of 2010 – 2020.
So in January 2023, when we saw an increase of 43% in announced buyback authorizations over January 2022, resulting in the highest recorded number of authorizations ever announced to start a new year, it seemed like great news for the possibility of history repeating itself.
Better still, as of February 17, 2023, authorizations announced so far this year reached $220 billion, a record for that timeframe. And best of all, according to S&P Dow Jones indices, given the current pace of buyback announcements, the 2023 calendar year could easily see more than a trillion dollars of buyback authorizations from companies making up the S&P 500.
This sounds amazing, doesn’t it? But, as the saying goes: “Houston, we have a problem.”
Despite the extraordinary pace of announced buybacks, companies aren’t actually in the market buying their shares commensurate with the record level of their announced intentions. In other words, they’re buying far fewer of their own shares than they claim to be.
The banks and brokerages that execute companies’ buyback programs (and I know how they operate because I used to run a trading desk that worked those orders) have bought about 10% fewer shares against programs than they bought for companies over that same period last year.
Goldman Sachs says the volumes are depressed and calls “buying underperforming authorizations” a worrying sign.
I agree. The slowing trend of buybacks is the new canary in the coal mine for the chances of a 2023 bull market.
Let me explain why this is a big problem and give you the single best move you can make right now to profit from it.
Why Buyback Volume is Declining
First of all, a quick aside: though some buyback bashers say companies who execute wasteful buybacks to enrich shareholders and management should be worried, don’t pay attention to new 1% tax on buybacks. The tax, which just went into effect in January, is already being called out by President Biden as too low. He wants to quadruple it. But record buyback announcements show the puny tax is of little consequence to CEOs.
Besides, buyback enthusiasts have Warren Buffett on their side, who just wrote in Berkshire’s latest annual letter to investors, “When you are told that all repurchases are harmful to shareholders or to the country, or particularly beneficial to CEOs, you are listening to either an economic illiterate or a silver-tongued demagogue (characters that are not mutually exclusive).”
Economics and market weakness are slowing down buybacks, not politics. So here’s what the numbers say.
Recent data out of Q4 earnings reports, with more than 90% of S&P 500 companies having reported, shows repurchases in Q4 were 18% below 2022’s Q4 buyback volumes. That may be one reason Q4 was a weak quarter in stock market performance terms.
Announced buybacks aren’t automatic. They are executed over years and always at the company’s discretion.
A trader executing buybacks on behalf of a program usually has discretion as to the timing of the buying they do, given the timeframe the company expects that desk to fulfill that portion of a program. For the most part, traders are expected to execute buy orders close to, or better yet, under the volume-weighted average price the stock trades at over a day, a week, or other timeframe given for an allotted dollar amount of the program to be executed. That means traders also have discretion.
There are several worrying signs to be read through the less-than-robust volume of actual buybacks happening, or not happening.
Companies may be holding back on giving buy orders to execution desks.
If CEOs and CFOs think the market is vulnerable to a pullback, they wouldn’t be in a rush to buy back their shares because they believe they’d look a lot better to shareholders if they buy them back at much lower levels.
Traders, who have longer latitude to execute buy orders, could also be waiting to buy shares if they think they’d be able to buy more shares at lower prices. That makes them look good to the CEOs and CFOs who allocate those profitable trading programs to desks vying for commissions and the ability to trade on order flows.
There are other reasons, besides company and trader discretion, why buybacks aren’t picking up.
The median forward earnings yield of 5.8% (earnings yield is earnings per share divided by share price; which is the reciprocal of PE or price/earnings) is now equal to the median cost to borrow money (if a company was financing buybacks ahead of cash flow and net earnings), with the rise in interest rates is now 5.8%. Only 18 months ago earnings yields were much higher, making buybacks smarter, and interest rates were lower, making financing costs a lot cheaper.
Cash flows are declining, especially at giant tech companies. That’s a worrisome fact in and of itself, but indicative of the hesitation to go into the market and buy shares back. And earnings projections are coming down at the fastest clip in a decade. That’s a really worrying sign not just for earnings metrics like “PE” and other valuation methods, but also in terms of buybacks.
Goldman Sachs, for example, expects buybacks to decline by 10% if there’s no earnings growth in 2023.
And if the economy falls into a recession? That’s a death knell for buybacks. They historically decline by 40% in a typical recession.
What Low Buyback Volume Is Telling Us… and What to Do About It
So here, then, is what the aforementioned canary’s song means:
After all that buybacks did for the Great Bull Market, any slowdown (or worse, buybacks coming to a standstill) means there won’t be any “corporate support” underlying a slipping market. That should worry all market investors.
There won’t be a “buyback bid” if the market breaks, because CEOs, CFOs, and trading desks wait for lower lows to start buying. And that means everyone needs to look out below, because the weak market could find itself further weakened without corporate buybacks’ support.
Fortunately for us, there’s a great way to play that, which is by buying put options on the S&P 500 while you’re waiting for these companies to execute on their buyback plans. That’s what I’m doing – you should too.