Buybacks are a big factor behind stock market boom
NEW YORK – It’s the narcissist rally.
Sure, there are plenty of forces pushing stocks higher – record corporate earnings, small investors finally buying again, signs the U.S. economy may be strengthening, central banks flooding the financial system with money.
But you may want to spare a thought, and a healthy dose of worry, for what is one of the biggest, and least appreciated, reasons for the rally: buybacks.
Flush with cash and a world of opportunity at their doorstep, companies have decided there’s nothing more attractive than themselves. So, they’re offering big money to buy back their own stock. This year, big U.S. companies have given the go-ahead for $286 billion of buybacks, up 88 percent from the same period last year, according to Birinyi Associates, a market research firm. If the pace continues for the rest of the year, the tally will exceed the record set in 2007.
Every manner of company is caught up in the buying binge, including home-improvement chains, makers of farm equipment and jet engines, airlines, sellers of soft drinks and of hard liquor alike. Not one to miss a hot trend, Apple recently authorized as much as $50 billion of buybacks.
Investors like buybacks because they suggest companies think their stock is cheap. They also help reduce the number of shares outstanding, which automatically increases earnings per share. And higher earnings per share often, though not always, lead to rising stock prices.
But buybacks are also crucial to the rally for a reason that’s not widely known. Companies are one of the few big stock purchasers nowadays. Nearly every other big player in the stock market has been selling more than they’ve been buying.
Pension funds have been selling. Local and state governments have been selling. Investment brokerages have been selling. And, yes, until recently, even Main Street investors.
You can see this in the data released by the Federal Reserve each quarter, and it’s a sea of red – save for corporate buying, that is, buybacks plus purchases of other companies. In total, U.S. companies, not counting banks and other financial firms, have bought more than $1 trillion of stock in the five years through 2012, net of stocks they’ve issued.
Experts note that companies may not spend all the money they have authorized on buybacks. But with investors clamoring for companies to return cash to them, either in dividends or buybacks, the odds are high that many will.
However much they spend, each dollar of buybacks appears to be having a greater effect on raising the prices of certain stocks. That’s because fewer shares are changing hands each day. On Wall Street, it’s referred to as a “drying up” of liquidity. And like in any market, a purchase or sale when fewer people are trading can push prices up and down much more.