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Home Depot is at another historic high on Tuesday following its excellent earnings report, but a major factor behind its stock price rise has been dividend hikes (it raised its dividend 29 percent on Tuesday), and an aggressive buyback program, including the new $15 billion share buyback program that it also announced.
To give you an idea of just how big a $15 billion buyback is, the company's market cap is roughly $175 billion, so we are talking about buying back nearly 9 percent of the company.
Even by the standards of the last decade, that is a big buyback.
Home Depot is part of a select group of companies I call "buyback monsters," companies that have bought back more than 25 percent of their shares since 2000.
Why 2000? Because most companies hit their highest levels of shares outstanding between 2000 and 2006; since then, most companies have been reducing share count, in some cases aggressively.
Consider Home Depot. In 2003, they had 2.36 billion shares outstanding, according to Factset. Today, they have 1.21 billion shares outstanding.
That is half the shares they had outstanding 14 years ago.
All other things being equal, that means earnings are twice as high as they would have been in 2003, when there were twice as many shares outstanding.
Home Depot isn't alone. IBM had 1.9 billion shares outstanding in 1997, today it has about 950 million, again less than half what it had 20 years ago.
ExxonMobil had 7 billion shares outstanding in 2000, today it has 4.1 billion, a reduction of about 42 percent.
This is not a trend that is limited by any one sector. There are companies that have been aggressively reducing their share counts in Industrials, Technology, and Consumer:
Consumers: share count reduction
Gap: 55 percent since 2005
Bed Bath & Beyond: 50 percent since 2005
McDonald's: 36 percent since 2000
Disney: 27 percent since 2006
Procter & Gamble: 24 percent since 2005
Why are there buybacks at all? They were originally used to support the issuance of stock options. The options increased the share count outstanding, so to keep the count down the company bought back shares.
But as the opportunity for significant top-line growth waned, buybacks to reduce share counts became a separate strategy to prop up earnings growth.
And that's my beef: Buybacks are a form of financial engineering. Here's another problem: It's not at all clear that buying companies just because they are buying back shares will be a successful investment strategy.
Take IBM — despite being one of the most aggressive buyback monsters on the Street, you can't say IBM's stock price has soared in the last decade. In 2014, the company eased off a bit on its buybacks, and the stock headed south.
It headed south because IBM was beset by fundamental growth issues: Its revenues from its old line businesses were shrinking and there was notrevenue from nascent businesses (like Watson and artificial intelligence) replacing it.
The lesson: No amount of financial engineering like buying back shares can replace management's inability to grow the business.
Not surprisingly, there are ETFs for all this, but their performance has been spotty. ThePowerShares Buyback Achievers ETF (PKW) tracks a market-cap-weighted index of companies that repurchased at least 5 percent of their outstanding shares in the previous 12 months. Top holdings include McDonald's, Boeing, and QUALCOMM.
Is the Donald Trump rally over?
Refresh my memory. Is this the fourth, fifth, or sixth time I have been asked this question by traders since mid-December?
I don't even know. The S&P 500 ended up roughly 1.3 percent for the week. But because the market tapped out at 2,351 Wednesday afternoon, and has drifted lower since then, there is the by-now usual wailing and gnashing of teeth, wondering if the Trump rally is over.
Relax. The two underpinnings of this rally — the Trump Rally, and the reflation trade — are both very much intact.
The reflation trade — the rise in interest rates and the slow, near-synchronous improvement in economies in the U.S., Europe, Asia and Latin America — is continuing.
The Trump trade — the lowering of corporate taxes, the reduction of regulation, and an infrastructure spending program — is also still very much intact.
It's intact despite the fact that President Trump has indicated that Obamacare may be a legislative priority over tax cuts. It's intact despite the fact that SenatorMike Crapo, chair of the Senate Banking Committee, said on Wednesday that regulatory reform will take 12 to 24 months.
You can argue — as my old colleague Ron Insana has — that risk is undervalued.
I won't argue with that. We should have more significant profit taking, but we're not getting it.
That tells me there is still a lot of momentum. We hit another historic high of 2,351 on Wednesday.
Don't you think we should at least see some technical deterioration before we declare the rally over?
But just look at how the market acts. Betting on a market drop has been a total loser. On days like Friday and Thursday, when the markets are down, there is no significant volume, which is a positive.
Everyone is hopeful that the market drops more so they can buy the dips, not get out.
The alternatives? Bonds don't look attractive given inflation, another reason to stay the course.
Where do we go from here? Have you noticed that all the strategic experts have been too conservative? The average strategist has been at roughly 2,350 for the S&P 500 by year-end, with only a few in the 2,400 range.
Well, we are already there. We're at 2,350. And it's only February!
What about Trump? Of course, his unpredictability is a problem, but look at what happened with the immigration order. He found out that there were some checks on his unpredictability.
On the economy, there are more ways that he can help than hurt.
That tells me there is no reason we can't go through 2,400 on the S&P 500.
Bottom line: the global backdrop is getting better. The earnings outlook is improving. The advance/decline line remains strong. Market leadership remains in financials and technology, supporting the recovery in cyclicals. Companies are making good money in the current environment, so changing the rules is just more gravy.
My take: unless you believe that there will be a huge disappointment in earnings this year, it's hard to argue that stocks are dramatically overvalued.
The worst thing you can say is that the market is a hold, with no big reason to sell.
Sure, it's a little boring some days, the volume is light, and the narrative has stayed the same for a while, but consolidation is a good thing.
It's not a table-pounding buy, but net-net, there's no reason you shouldn't stay with stocks.
What's up with oil?
It was down yesterday morning on reports of higher inventories, then higher later in the day on vague reports OPEC was considering extending supply cuts.
Despite the confusing signals, energy stocks are sending a very negative story: Oil is likely to remain in the low $50s for the rest of the year.
The evidence is everywhere. Chevron is at a new low for the year. ExxonMobil is trading like death, down nearly 9 percent for the year. The SPDR S&P Oil & Gas Exploration & Production ETF, heavily weighted toward U.S. producers, is down nearly 5 percent for the year.
Look, I know the drill, this sector was going out of business at this time last year. It's had a tremendous move since the February 2016 bottom, up 25 percent or more. It rallied into the end of last year.
I know all that. But I also know the market has been drifting higher since the beginning of the year and oil stocks have been drifting lower. And it's not a one-day affair. It's a clear trend.
A reasonable conclusion is that there is a valuation problem for Energy stocks. The markets are still discounting a significantly higher price for oil, and a lot of people seem to doubt it is coming.
How much higher? I don't know, but a lot of people at the end of last year were talking about oil in the $60s or even $70s in 2017.
The bulls still believe we are in an up-cycle. "Demand keeps growing, OPEC has pulled back, technology continues to improve well results (and returns), fast production declines from shale wells still need to get replaced," one hedge fund trader specializing in trading oil stocks told me today.
But look at the supply side. Traders have noted that more than 200 additional rigs have been added. U.S. production is back up to 9 million barrels a day.
The bulls keep talking about the fact that a number of companies raised their estimates for capital expenditures. That's good news for oil service companies, but it doesn't change the facts: they are throwing a lot more money into a market that is well oversupplied.
Are the markets worried about a slowdown in the Trump Agenda?
Some are indeed worried about it, but the markets are keeping the faith—at least so far.
Greg Valliere at Horizon Investments summed up the concern this morning: "[O]ne of the reasons the stock market rallied in recent months was the prospect of action in Washington on these four major bills—and suddenly they seem bogged down."
He was referring to the core Trump Agenda of lowering taxes, reducing regulations, and enacting an infrastructure reform bill, and replacing Obamacare.
Regardless: the markets have shown no signs of losing faith that this agenda can get passed, at least not yet.
Consider that stocks rallied this morning as President Trump, meeting with retail CEOs at the White House, reiterated that he "will lower rates very, very substantially, including personal and business" rates.
While the president did not mention tax cuts during his press conference with Israeli Prime Minister Benjamin Netanyahu, the trading community is expecting that he will flesh out his tax cut plan during his address to Congress on Feb. 28. It's likely his team may leak details out ahead of that speech.
Another reason the markets are not falling apart is that it's not just about Trump. I noted yesterday that the rally has turned global. The global economy--and global earnings--are improving.
We also saw further evidence this morning that the U.S. economy was continuing to improve. Consumer prices--a gauge of inflation--and retail sales in January were both stronger than expected. Strong retail sales indicate the U.S. economy continues to improve. Higher consumer prices — which are up 2.5 percent year over year, the highest in almost 5 years — indicates that the so-called "reflation trade" is very much in place, a trade that is lifting prices on everything from commodities to finished goods, and lifting profits as well.
The focus on the breakout in U.S. stocks is overshadowing an equally important event: a global stock market breakout. While the U.S. is up roughly 3 percent for the year, the rest of the world is outperforming, including emerging markets, Japan and Europe — up 9 percent, 5 percent and nearly 5 percent year to date, respectively.
What's behind the outperformance? Consider:
What could keep the rally going? Upward revisions in earnings growth, for one, starting with the United States. Bank of America noted that while 2017 guidance from U.S. corporations has been typically tepid since they want to set the bar low, the commentary on conference calls has been far more optimistic — literally. The word "optimistic" was used on a record 51 percent of the calls BofA monitored this quarter, the highest since they began monitoring this data in 2003.
"This optimism could translate into future earnings revisions," BofA wrote.
The major indices opened at record highs yet again on Monday, with cyclicals like Financials, Industrials, and Materials all leading. The Dow Industrials have moved about 270 points or 1.3 percent since Thursday morning, when President Trump said he would have more news on a tax cut in the next few weeks. House Speaker Paul Ryan already said that no action would be forthcoming before spring at the earliest, but no matter. Just word that the president might have something soon is sending markets higher.
The S&P 500, the main index watched by professionals, topped $20 trillion in value for the first time this morning. The S&P 500 is the 500 largest stocks in the U.S., but there's about 4,000 companies that are actively traded. The Russell 3000, which is the largest 3,000 stocks that trade, has a market value of about $25 trillion. So the top 500 stocks have a value of about $20 trillion, and the remaining 2,500 have a value of only about $5 trillion more.
That tells you that the biggest stocks really are getting bigger.
Why is that? Partly, it is the triumph of indexing. The three largest ETFs that track the S&P 500—the SPDR S&P 500 (SPY), iShares Core S&P 500 (IVV), and Vanguard S&P 500 (VOO), collectively have about $358 billion in assets under management, about 14 percentof the $2.5 trillion in assets for the entire ETF industry. Because it's easy to push money into indexes, and the S&P 500 is the most well-known index, the big keep getting bigger.
Conditions are ripe for mutual fund managers to outperform. But even a near-perfect environment may not be enough.
"All are on the same page, including hawks and doves," says one bond strategist of officials at the Federal Reserve.
Palo Alto Networks reported their second quarter 2017 earnings Tuesday, with a revenue miss sending shares plunging in after-hours trading.