Where Oh Where Has the Rally Gone?

By: David Haggith

Quarterly Share Repurchases


Last week began the blackout period for companies buying back their own shares, as we are nearing the end of a quarter, when stock buybacks are put on hold. It also began the bust of the stock market's recent rally. If you followed my last article, you'd see that this is exactly what I expected the stock market to do because nearly all of the buoyancy in the recent market rally has been created by companies buying back stocks and sometimes focusing the buybacks on specific major shareholders.

The big players use stock buybacks to save themselves

Take a look at the chart above, which shows how the stock market is almost exactly tracking stock buybacks. Note the last time buybacks hit a zenith (in 2008) similar to the present. As soon as stock buybacks ended, the stock market crashed. As the market grew more desperate, there were more buybacks by corporations in an attempt to keep their share prices rising but perhaps also as an engineered exit for major stockholders. (Use the company money to buy back shares so that massive buybacks don't have any negative impact on stock prices.)

With some stock buybacks currently focusing on buying back shares from major shareholders at a set price (versus buying back shares on the general open market), you don't have to be a genius to realize those major company owners, who usually have a seat on the board, must want to get out in a hurry, now, too.

In my opinion, that is all this rally was -- a last hurrah in which the major players and those corporate leaders, who are paid in stock options, are seeking to save themselves, slick weasels that they are.
As a reminder, even Bloomberg recently acknowledged the unprecedented role corporate stock repurchases play in the current market when it penned "There's Only One Buyer Keeping S&P 500's Bull Market Alive." - Zero Hedge
That buyer is the company, itself, as led by the board members and CEOs who are saving themselves by taking out company debt or using company cash for the company to use to buy back their shares. Turning the company into a massive buyer of its own stocks assures that dumping their own shares as quickly as legally possible won't erode the market price. It's a backdoor exit with a golden carpet.
Bank of America reported ... in the latest week "during which the S&P 500 climbed 1.1% ... net sales ... were ... led by institutional clients (where net sales by this group were the second-largest in our data history)."
In other words, among BofA's clients, it's the biggest investors that are getting out quickly.

Institutional clients are often the major stockholders because of the amount of money they have to invest. Therefore, you also don't have to be a genius to realize that once they have saved themselves, the buybacks will diminish and stock prices will fall as that last-remaining support for the market is pulled away. It is merely a question of how long it will take them to close their positions.
BofA's summary: "clients don't believe the rally, continue to sell US stocks" and they were selling specifically to corporations whose repurchasing activity is near all time highs: "buybacks by corporate clients accelerated for the third consecutive week to their highest level in six months."
They don't believe the rally because they know they are the ones creating it by using company cash and credit to buy themselves out. Once again, you don't have to be a genius to realize that, when this kind of corporate incest reaches an all-time high, it's usually not too far from falling off a Cliff.


Have we reached a point where buybacks will rapidly diminish as happened in 2008?

We got a taste of the impact of ending stock buybacks last week when the blackout period began. The rally did not continue without that major support, but that's only temporary because buybacks, when they are popular, normally resume after the reporting period is over.

However, we may be nearing a more significant market top, and buybacks may also be reaching their own natural end.
UBS chartists and technicians Muller and Riesner have now publicly stated we might have seen another top of the S&P 500 index. And when Muller and Riesner speak up, the investment community listens, as these two technical analysts have correctly predicted the two previous corrections.... To the UBS-analysts, the S&P index has now reached its most overbought situation since 2009, and that's quite a statement to make! - ContraCorner


While the blackout period is only temporary, the bigger question is whether or not buybacks will resume in such significant numbers after the blackout. We have reached another point of diminishing returns where buybacks are becoming less effective as a means of raising stock prices.

The largest percentage of stock buybacks in the last year happened in the technology sector among those companies that were once the only companies keeping the S&P 500's head above water. Apple bought back $40 billion in shares; yet it's shares still lost 15.5% of their value! That means simply that more investors wanted out of Apple's stock than Apple's mega buybacks could make up for.

Apple failed as one of the few major supports for the bull market, inspire of its large stock buyback program. Many other companies experienced the same diminishing returns for their stock buyback programs by the end of last year. That could be a sign that we have reached the natural the end of long buyback period.

I'm not the only one who sees the huge growth in stock buybacks as the method by which rats flee a sinking ship. Jim Quinn of The Burning Platform writes,
Corporate earnings reports for the fourth quarter are pretty much in the books.  
The deception, falsification, accounting manipulation, and propaganda utilized by mega-corporations and their compliant corporate media mouthpieces has been outrageously blatant. It reeks of desperation as the Wall Street shysters attempt to extract the last dollar from their muppet clients before this house of cards collapses. 
The CEOs of these mega-corporations accelerated their debt financed stock buybacks in 2015 as stock prices reached all-time highs and are currently so overvalued, they will deliver 0% returns over the next decade. This disgraceful act of pure greed by the Ivy League educated leaders of corporate America to boost their own stock based compensation is reckless and absurd. 
It is proof education at our most prestigious universities has produced avaricious MBAs following financial models and each other like lemmings going over the cliff.
Quinn also notes that the previous nadir in stock buybacks was in 2008, and that's when the lemmings fell over the cliff. The number of companies engaging in buybacks back then was at the same level it has reached now. (Evil contains the seeds of its own destruction, and whenever any kind of evil, such as greed, reaches an historic high point, it usually burns itself out.)
When a dead retailer walking like Macy's, which is seeing it's sales fall and profits crater by 30%, announces a $1.5 billion stock buyback when it already is weighed down with $7 billion in debt, you realize the men running these companies have no common sense or concern for the long-term viability of their companies. They'll get a golden parachute no matter how badly they screw the pooch.
People have no concern for the long-term viability of their companies when their goal is to take the money now and run. I believe the present bear-market rally reached as high as it did is because the big guys are looking out for themselves and getting their golden parachutes properly packed.

(I recommend reading the the rest of Quinn's article once you're done here to get a picture of the kinds of accounting games that major CEOs now routinely play to cover their tracks. I won't go into that here because this article is just about the buybacks and their role in a bear-market rally. We have moved far from the days of Generally Accepted Accounting Practices (GAAP), and most of the press is too lazy and bimbo-headed to question any of the profit figures thrown at it. They go for the low-hanging fruit when they are reporting, simply reporting the stories that are placed fully ripened in their hands.)

Other factors contributing to the likely curtailment of stock buybacks

Buyback activity now faces slowly rising interest rates, which will make it harder for companies to borrow in order to buy back shares. It also faces declining profits, meaning less cash to use for buybacks. So, those are two other natural reasons for market support from stock buybacks to fall away.

Analysts collectively downgraded first-quarter profit forecasts over the last three months by almost ten percentage points. That's the most rapid downgrade in forecasts since ... the Great Recession.

Here is what profit growth looks like during the "Great Recovery":

Five Quarters of Negative Growth

We have gone from rapidly diminishing returns to flat returns and now to negative returns; but share prices escalated. Clearly share prices did not rise because of growing profitability. They rose in spite of it, exactly matching the rate of share buybacks made easy by Fed stimulus, which is slowly fading on the rear horizon.

Buybacks are, as has often been pointed out about the past bull market, "long in the tooth."

You can see in the first graph I presented that they have already run on longer than they did in the lead-up to the crash of 2008. I think that is just because the stock market is much higher in price, so people have greater positions to recover in trying to cash out of the market. Money for buybacks has also been much more available this time around as many players are banks that were fed free Fed money to invest. All others have had access to cheap interest.

Major sign of the profitability problem: the Caterpillar is slowing eating itself

A good bellwether of this decline in heavy industry profits is the giant-machine giant Caterpillar.

While Cat stock has soared 30% from its earlier lows this year, its sales have been declining for 39 months, the longest decline in its history, and in February it experienced its largest monthly decline in five years -- a 21% crash, which followed a 15% plunge in January. It's sales have been falling precipitously in every market, including the US. At this rate, if sales decline any more, Caterpillar stocks could outperform Apple. While that sounds like it doesn't make sense, it is the way the Caterpillar has been crawling.

How do you explain the huge rise in Cat's stock value with such longterm and worsening profitability. Simple. Just look at this company press release:
CATERPILLAR ANNOUNCES $1.5 BILLION ACCELERATED STOCK REPURCHASE 

July 28, 2015 
"Repurchasing an additional $1.5 billion of Caterpillar stock in the third quarter of 2015 will bring our total 2015 stock repurchases to approximately $2 billion. In addition to the stock repurchase, our Board of Directors recently raised the quarterly dividend by 10 percent, further demonstrating our commitment to stockholders."
Caterpillar stock is only popular because it guarantees good capital returns with its dividends and by feeding on itself with stock buybacks. Instead of investing in its future, Cat is cannibalizing itself to its investors. Share buybacks are more popular than dividends because of tax advantages. It's a finite game, though, because a caterpillar can only eat its own tail until it gets back to its head.

The last time Caterpillar engaged in this kind of rampant activity was in the run-up to the 2008-2009 crash. As indicated in the initial graph, the same can be said of many companies.
While companies are buying back far more stock than they did a decade ago, they have also invested less in plants, equipment and research. - WSJ
That doesn't bode well for the future. It's sort of like giving all your kids an early inheritance, which you pay for by not investing in their education. It's not the best plan for your family's future. Like everything we've done during the "Great Recovery," it's not sustainable.

Our revels now are ended

While the stock market's past bull run was supported largely by stock buybacks, the recent rally got a lot of support from the rise in oil prices, which caused bullish investors -- a mass of people collectively as intellectual as turkeys -- to think that problems leading to mass defaults throughout the oil industry were backing off. Oil prices, however, have started falling again because (surprise, surprise, if this is your first time reading here) Iran didn't join the production freeze.
"Investors are questioning this explosive near-term rally off February lows, which left stocks in an overbought condition. And the main reason for the rally seems to be tied to oil," said Channing Smith, portfolio manager at Capital Advisors, referring to a weekslong stock rally since Feb. 11, when stocks touched their 2016 nadir. "It seems everyone is trying to find evidence to justify it, but economic data seem hollow, nothing to suggest acceleration," Smith said. - MoneyMarket
If oil support fades, as it looks like it could be starting to do again, and buybacks don't return in force, the rally is terminated.
Since the ending of QE in late 2014 one thing about the "markets" has been crystallizing more and more for everyone to see. Even if they try to turn their heads, it can no longer be avoided: without central bank (and now that includes all CB's) continuous intervention - there is no [stock] market. It all falls apart like the house-of-cards that it is.... The markets will at first vacillate in place until they relent and plummet in unison.  
- MarkStCyr.com

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