The Case of the Missing Buybacks

As many seek explanations for stocks’ rise since March 23, we think it is worth highlighting one factor virtually no one will likely land on: corporate share buybacks. These have cratered lately as companies—many of them shuttered by COVID lockdowns—tightened their belts in response to shrinking revenues. In our view, this undercuts the recurring claim during the last bull market that buybacks were the only force driving stocks higher—and should call into question theories arguing any single factor underpins demand.

Many, many firms are seeking myriad ways to bolster their balance sheets and add liquidity. Early on, there were plentiful reports that smaller firms were seeking to tap credit lines simply to increase cash on hand. Now it seems many small firms are issuing new shares via secondary offerings to raise liquidity. Hence, it is perhaps unsurprising that buybacks have tanked. We see this as a sensible move in many ways—one that should help firms meet near-term financial needs and provide something of a safeguard if financial pressure persists. Beyond businesses’ voluntarily dialing back repurchases, any company drawing on CARES Act relief funds is legally barred from buying back shares until a year after it repays the loan. This confluence of factors has driven over one-third of S&P 500 companies to suspend buyback programs since the crisis erupted.^[i] On Tuesday, Bank of America noted year to date buybacks among their corporate clients—which have directionally tracked S&P 500 company buybacks since 2010—are 43% lower than this same time last year.^[ii]

Yet buybacks’ absence doesn’t seem to have hindered US stocks much. The S&P 500 has surged 39.7% off March 23’s low, albeit with occasional volatility.[iii] Considering efficient markets rapidly incorporate widely known information—and buyback plans are publicly announced—any negative impact from cutting share repurchase plans should already be reflected.

More generally, we see markets’ rise as powerful evidence against the oft-heard claim that buybacks were the only source of stock demand at various points in the 2009 – 2020 bull market. Consider this smattering of headlines:

• Wall Street’s New Drug Is the Stock Buyback (MarketWatch, 7/21/2015)
• Companies Buying Back Their Own Shares Is the Only Thing Keeping the Stock Market Afloat Right Now (CNBC, 7/2/2018)
• This Stock Market Rally Has Everything, Except Investors (The New York Times, 2/25/2019)

Likewise, when buybacks dipped, coverage fretted the loss of a key demand source.

• Bull Market Losing Big Ally as Buybacks Fall Most Since 2009 (Bloomberg, 5/15/2016)
• A Slowdown in Stock Buybacks May Be a Bad Omen (MarketWatch, 4/26/2017)
• Here’s Another Theory for This Week’s Market Skid—The ‘Buyback Blackout’ (CNBC, 10/11/2018)

There is a grain of truth to these. Buybacks shrink share supply—all else equal, a bullish force, since stock prices are a function of supply and demand. But buyback volumes are just a sliver of stock market capitalization—too small to make much of a splash. Companies also frequently use them in part to offset new stock issuance in the form of stock-based employee compensation, which mitigates issuance’s potential diluting effect. More importantly, stocks are an auction marketplace in which buyers’ and sellers’ relative eagerness—not their quantity—drives prices. For every buyer, there is a seller. If companies are buying, others are necessarily selling to them.

If buybacks drove returns, you would expect firms buying their own shares to permanently outperform broad indexes. But if you compare the S&P 500 Buyback Index (an equal-weighted index of 100 US firms with high buyback activity) to the equal-weighted S&P 500, you find it doesn’t. Since 2010, the earliest data available, it has outperformed in seven years and underperformed in three. Although this is a very short history, it seems to us big share repurchasers likely have periods of leadership and underperformance just like any other stock category. Again, we think buybacks are a bullish driver. But they are only one factor, with no superpowers to overwhelm others.

Another common refrain during the last bull market was that buybacks signaled companies were optimistic about their futures—thus making falling buybacks a bad sign. But there are many possible reasons to trim buybacks—like deciding to return money to shareholders via dividends instead; opting to use the money for capital expenditures or acquisitions; reducing stock-based compensation; and conserving cash to weather hard times. Regarding the latter, buyback levels often fall during bear markets or corrections, making it appear as though markets rely on them. But this confuses cause and effect. Market volatility often coincides with recession fears—and in the case of bear markets, it precedes actual recessions. Companies often react to these by scaling back discretionary expenditures, including buybacks and dividends—just as we see now! But the reaction is after the fact, not the cause.

The lesson from all this, in our view: Be wary of any theory alleging this or that demand source is the only thing driving stocks. In our view, this is oversimplified thinking and misperceives how markets function. It may also lead investors to view bull market rallies as artificial, fragile and temporary. There are billions of market participants, all acting for a huge variety of reasons. Hence, the likelihood anyone can boil down a rally’s drivers to a single thing—be it buybacks, the Fed or bored quarantined investors with stimulus money—is exceedingly low, in our view.