Buybacks could be the stock market savior this year

Here's why stock buybacks help
Here's why stock buybacks help   

In a year that looks increasingly dismal for stock market returns, companies may have to come to their own rescue.

Retail investors are bailing on stocks, pulling money from domestic equity funds every week in 2016. No wonder: The S&P 500 was down 8 percent year to date even before Monday's market plunge, a bad sign for a market that historically takes its full-year cue from how things transpire early on.

The good news is that companies appear willing to step into the void.

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Share buybacks and dividend issuance collectively have been a major tailwind for the post-financial crisis bull market, which will turn 7 years old in a month if it can manage to hang on through the current volatility. Low historical valuations combined with cheap money have pushed corporations to return trillions to investors.

With the blackout period over for buyback announcements, Wall Street is expecting big things.

Early indications are that 2016 buybacks are "on pace to be one of the fastest starts on record," David Kostin, chief U.S. equity strategist at Goldman Sachs, said in a note his team sent to clients this weekend.

Traders on the floor of the New York Stock Exchange.
Getty Images
Traders on the floor of the New York Stock Exchange.

Announcements so far have totaled $63 billion barely a month into the year, and Kostin thinks that's just the beginning.

"Companies have generally expressed a continued commitment to buybacks, holding the view that market weakness is a reason to increase, rather than taper, their repurchases," he said.

Buybacks totaled $724 billion in 2015, a year that ranked second only to 2007 in total volume, according to market data research firm TrimTabs. The year did set a record for most corporate money used for buybacks and cash takeovers, at $1.41 trillion.

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Of course, a comparison with 2007 doesn't necessarily bode well for the market, considering that was the year the housing-led bull market began to crumble.

But market conditions then were different: Optimism generally was running high, with equity allocations near 70 percent in 2007. Investors now remain wary of the stock market, with Goldman's own indicator putting sentiment at 2 on a scale of 1 to 100. Kostin said that indicates a likely market rise of 4 percent in the next month, based largely on corporate buyers filling the gap left by leery retail investors.

"Management optimism is important to the market because corporates represent the primary source of demand for U.S. equities even outside of the current environment," he said. "The increase in buyback activity following 4Q earnings season typically coincides with the outperformance of large buyback stocks."

Identifying individual companies, Kostin said those poised for significant buybacks include Gilead Sciences, which indicated $12 billion on the way, and 3M, with $10 billion. In addition, GE is poised for a large cash deployment for an unspecified mix of buybacks and dividends, while Apple, Microsoft and Qualcomm also have significant cash on hand to devote to buybacks.

While the surge in buybacks has coincided with the sharp run-up in stock prices broadly, putting money specifically toward companies that use their cash in that manner has had mixed success.

The SDPR S&P Buyback ETF, a relatively new fund introduced just over a year ago, has outperformed the S&P 500 in 2016 but is still down 6.7 percent. The fund is down 16.3 percent over its brief time span. By contrast, the PKW PowerShares BuyBack Achievers fund, which is focused on share-reducing firms in the Nasdaq tech index, is up 55 percent over the past five years.