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Trader Notes: Are Buybacks driven the Stock Market Rally?



Definitely, YES. And they have the main credit for the stock market's rally since the 2009 crisis, and especially the latest years as they been reinforced during Trump's government due to the Tax Reform. It is enough to watch buyback' charts prepared by investment analysts to verify it, I add some of them below. 

Briefly, let's define the stock buyback. And what a better way to explain it that Investopedia, which defines that "a buyback, also known as a share repurchase, is when a company buys its own outstanding shares to reduce the number of shares available on the open market. Companies buy back shares for a number of reasons, such as to increase the value of remaining shares available by reducing the supply or to prevent other shareholders from taking a controlling stake." In days of a struggling economy, where get growth and profit increases are difficult, buybacks seem a good reason for companies to artificially inflate their share price.




Example of a Buyback


A simple numeric example, the best way to understand this, also taken from Investopedia: "A company's stock price has underperformed its competitor's stock even though it has had a solid year financially. To reward investors and provide a return to them, the company announces a share buyback program to repurchase 10 percent of its outstanding shares at the current market price."

Continue: "The company had $1 million in earnings and 1 million outstanding shares before the buyback, equating to earnings per share (EPS) of $1. Trading at a $20 per share stock price, its P/E ratio is 20. With all else being equal, 100,000 shares would be repurchased and the new EPS would be $1.11, or $1 million in earnings spread out over 900,000 shares. To keep the same P/E ratio of 20, shares would need to trade up 11 percent, to $22.22"

That's the reason:  no pay dividends, I prefer a share repurchase, which artificially raises the stock price. Great earnings season forever. Abnormally high levels of buybacks in the latest years generate an SP500 rising every year, despite real macroeconomic problems behind (incoming recession, Trade War and Brexit with no solution, inverted yield curve, manufacturing+services sector' contraction, negative interest rates, bond bubble, and so on). Investors, traders, people, Trump, and all Wall Street living a false illusion today, happy and carefree, hovering around its historical all-time highs. 



This 2019 was especially aggressive in stock repurchase (yellow columns) above the 2010-2018 average (black columns). But, the year 2020 seems unpredictable. Probably the next US recession halts this situation as this can't hold forever.





Let's watch more crazy charts


1. Ned Davis Research measures the impact of share repurchase over the last nine years and found a significant effect. One of its four scenarios "buyback funds used to pay dividends" is shown above: watch that the SP500 would have been 10% lower. Given that growth stocks with high momentum have powered market gains since 2010, buybacks have been a particularly efficient strategy for creating shareholder return during this period.


2. In this chart, Goldman Sachs compares the accumulated flows for different cases since the subprime mortgage crisis. Amazing the spread: yellow line shows money from SP500 stock repurchases (now $5 trillion!) growing every year since 2009, while other instruments as households, foreigners, and funds exhibit disappointing numbers. But, be careful, a recent report from the same Goldman Sachs warns that corporate buybacks are “plummeting” as companies tighten their purse strings, and it could have a big impact on the market. The boom may begin to slow in 2020: time for look for high-dividend stocks? Is the end of the bull market?





And last week finished the Buyback Blackout...


It is a usual theory on Wall Street that the market indexes dip during the days in which companies can't buyback its shares (usually a few weeks prior to reporting earnings and ends a few days after it). That period is called the blackout. It's incredible how the SP500 chart really whipsaws or corrects during the blackout periods, creating so a great key for well-informed traders.  




For short-term investors and swing-traders this chart is gold: shows that the buyback blackout period began to ease since mid-October, and today many companies are ready to repurchase its shares. And matches wi
th October 26th, according to Seasonax, the historically day when begins the usual Christmas rally (if this year comes) and,  seasonally, the best bullish weeks in Wall Street.