Share buybacks are one of this year’s red-hot topics in the US and regularly hit the headlines, amid claims that the bullish equity market is underpinned solely by this factor, or that it increases social inequalities. Without wishing to enter into this sterile debate, it transpires that the dominant belief on Wall Street is that US companies are buying-back their own shares in droves and thus contributing to the market advance. When a company buys back its own shares, it reduces the total number of shares in circulation and therefore increases earnings per share, thus remunerating remaining shareholders and theoretically triggering an increase in the share price. Given that three quarters of the S&P 500 component companies are currently implementing share buybacks, it would not be a great leap to conclude that these programmes have a major impact. Is this really the case?
Since the beginning of the current equity market cycle, share buyback programmes have been a recurrent theme in the US, chiefly on account of earnings growth, increased financial leverage and, more recently, tax reform. Over the past few years, the main source of equity demand in the US has stemmed from companies themselves, via share buyback programmes, which has exceeded demand from ETFs. According to JP Morgan[i], since 2008 share buybacks implemented in the US have totalled USD 4.5 trillion, i.e. the equivalent of 30% of the increase in market cap during this period, which provides a clear illustration of the scale of share buyback programmes. Over the past 12 months, we estimate the value of share buybacks to be USD 640 billion, 30% higher than that of the previous 12 months[ii]. For the full year 2018, buybacks could even increase by over 40% compared to 2017 and exceed USD 800 billion. For 2019, Goldman Sachs estimates that buybacks should increase by over 20% to a new all-time high of almost USD 1 trillion[iii]. These colossal amounts are all the more significant as companies are expected to deploy the greatest proportion of their cash this year and in 2019 for share buybacks (more than for capex) for the first time since 2007. With cash-to-asset ratios close to their all-time highs of 12%, US companies have ample means to launch ambitious share buyback programmes.
The US tax reform introduced by the Trump administration in December 2017, which was one of the most significant in US history, has played a key role by reducing corporate tax from 35% to 21% and enabling multinational companies to repatriate an estimated USD 2.5 trillion of cash held abroad at a preferential tax rate. After nine months, it would appear that half of the total amount effectively repatriated has been used to either step-up or launch share buyback programmes, hence their spectacular increase during 2018 and 2019. As evidence, less than 15% of buybacks carried out in 2018 were financed by debt, compared to over 30% in 2017.
We do not share the prevailing enthusiasm for share buybacks, however. Firstly, over the past 12 months, almost 45% of the total amount have been repurchased by 20 companies, led by Apple, Oracle and JP Morgan. Such a high level of concentration cannot benefit the whole market. Secondly, although buyback totals are at an all-time high, it is also important to highlight that market value is also at record levels and that the market cap of the S&P 500 index breached USD 25 trillion for the first time just before the October correction. The value of equities bought back over the past 12 months, despite appearing to be an exorbitant amount, represents just 2.7% of the current market cap of the S&P 500, far below the peaks reached in 2007 and 2013 of over 5%. Lastly, a strategy focusing on shares with a generous buyback yield (trailing 12-month buyback amount / market cap) incurs high risks. Many of these companies have capitalised on the post-crisis low interest rate environment to finance ambitious share buyback programmes and are therefore now more heavily leveraged than average, as demonstrated by the net debt / EBITDA ratio of the S&P 500 Buyback index[iv]. In the current increasing interest rate context, these companies are beginning to lose favour with investors.
In theory, if share buybacks strongly support the markets, then the stocks with the highest buyback yields should outperform. Our tests have effectively demonstrated that a stock-picking strategy based on the 100 S&P 500 components with the highest buyback yield[v] has been highly profitable since the beginning of the bull market cycle in March 2009. This strategy, in an equally-weighted version, outperformed the market by 11% annually, whereas a market-cap weighted version outperformed by 4%. However, these portfolios have a high tracking error to the S&P 500 index[vi] and their relative performance results chiefly from sector deviations[vii]. In order to better assess the intrinsic pertinence of share buybacks as a risk factor, we have divided the investment universe into quintiles based on buyback yield and neutralised sector weightings. This approach does not enable us to conclude that share buybacks add value. Only one of the four versions tested[viii] proved convincing in terms of its outperformance profile. Large-scale share buyback programmes alone no longer suffice for companies to beat the market.
Share buybacks are a technical factor, which although certainly positive, is currently only a small cog in the mechanism driving equities higher. Although their value in 2018 and 2019 has reached all-time highs and has also hit the headlines, they are concentrated among a few giant companies and remain moderate compared to the overall scale of the US equity market. The added value delivered by stock-picking strategies based on share buybacks is very probably attributable more to sector exposure than to the intrinsic value of this particular risk factor. Lastly, we believe that the continued rise in the market is based primarily on growth in sales and earnings and therefore on the strength of the economic cycle at a time when margins are already very high.
[i]Source: JP Morgan, US Equity Strategy, 18 October 2018
[ii]Sources: Reyl & Cie, Bloomberg
[iii]Source: Goldman Sachs, Portfolio Strategy Research, 4 October 2018
[iv]The 100 S&P 500 stocks with the highest buyback yield delayed by one quarter, rebalanced quarterly, equally-weighted
[v]The 100 S&P 500 stocks with the highest buyback yield delayed by one quarter, rebalanced monthly, equally-weighted
[vi]2.9% for the market-cap weighted portfolio and 4.2% for the equally-weighted portfolio
[vii]As of 26.10.2018 the 5 sharpest sector fluctuations are discretionary consumer (+9.5%), financials (+9.2%), industrials (+6.2%), communication services (-6.8%), tech stocks (-5.7%)
[viii]Monthly and bi-annual rebalancing, equally-weighted and market-cap weighted
Not company earnings, not data but vaccines now steering investor sentiment
By Marc Jones and Dhara Ranasinghe
LONDON (Reuters) – Forget economic data releases and corporate trading statements — vaccine rollout progress is what fund managers and analysts are watching to gauge which markets may recover quickest from the COVID-19 devastation and to guide their investment decisions.
Consensus is for world economic growth to rebound this year above 5%, while Refinitiv I/B/E/S forecasts that 2021 earnings will expand 38% and 21% in Europe and the United States respectively.
Yet those projections and investment themes hinge almost entirely on how quickly inoculation campaigns progress; new COVID-19 strains and fresh lockdown extensions make official data releases and company profit-loss statements hopelessly out of date for anyone who uses them to guide investment decisions.
“The vaccine race remains the major wild card here. It will shape the outlook and perceptions of global growth leadership in 2021,” said Mark McCormick, head of currency strategy at TD Securities.
“While vaccines could reinforce a more synchronized recovery in the second half (2021), the early numbers reinforce the shifting fundamental between the United States, euro zone and others.”
The question is which country will be first to vaccinate 60%-70% of its population — the threshold generally seen as conferring herd immunity, where factories, bars and hotels can safely reopen. Delays could necessitate more stimulus from governments and central banks.
Patchy vaccine progress has forced some to push back initial estimates of when herd immunity could be reached. Deutsche Bank says late autumn is now more realistic than summer, though it expects the northern hemisphere spring to be a turning point, with 20%-25% of people vaccinated and restrictions slowly being lifted.
But race winners are already becoming evident, above all Israel, where a speedy immunisation campaign has brought a torrent of investment into its markets and pushed the shekel to quarter-century highs.
(Graphic: Vaccinations per 100 people by country, https://fingfx.thomsonreuters.com/gfx/mkt/azgvolalapd/Pasted%20image%201611247476583.png)
SHOT IN THE ARM
Others such as South Africa and Brazil, slower to get off the ground, have been punished by markets.
Britain’s pound meanwhile is at eight-month highs versus the euro which analysts attribute partly to better vaccination prospects; about 5 million people have had their first shot with numbers doubling in the past week.
Shamik Dhar, chief economist at BNY Mellon Investment Management expects double-digit GDP bouncebacks in Britain and the United States but noted sluggish euro zone progress.
“It is harder in the euro zone, the outlook is a bit more cloudy there as it looks like it will take longer to get herd immunity (due to slower vaccine programmes),” he added.
The euro bloc currently lags the likes of Britain and Israel in terms of per capita coverage, leading Germany to extend a hard lockdown until Feb. 14, while France and Netherlands are moving to impose night-time curfews.
Jack Allen-Reynolds, senior European economist at Capital Economics, said the slow vaccine progress and lockdowns had led him to revise down his euro zone 2021 GDP forecasts by a whole percentage point to 4%.
“We assume GDP gets back to pre-pandemic levels around 2022…the general story is that we think the euro zone will recover more slowly than US and UK.”
The United States, which started vaccinating its population last month, is also ahead of most other major economies with its vaccination rollout running at a rate of about 5 per 100.
Deutsche said at current rates 70 million Americans would have been immunised around April, the threshold for protecting the most vulnerable.
Some such as Eric Baurmeister, head of emerging markets fixed income at Morgan Stanley Investment Management, highlight risks to the vaccine trade, noting that markets appear to have more or less priced normality being restored, leaving room for disappointment.
Broadly though the view is that eventually consumers will channel pent-up savings into travel, shopping and entertainment, against a backdrop of abundant stimulus. In the meantime, investors are just trying to capture market moves when lockdowns are eased, said Hans Peterson global head of asset allocation at SEB Investment Management.
“All (market) moves depend now on the lower pace of infections,” Peterson said. “If that reverts, we have to go back to investing in the FAANGS (U.S. tech stocks) for good or for bad.”
(GRAPHIC: Renewed surge in COVID-19 across Europe – https://fingfx.thomsonreuters.com/gfx/mkt/xegvbejqwpq/COVID2101.PNG)
(Reporting by Dhara Ranasinghe and Marc Jones; Additional reporting by Karin Strohecker; Writing by Sujata Rao; Editing by Hugh Lawson)
BlackRock to add bitcoin as eligible investment to two funds
By David Randall
(Reuters) – BlackRock Inc, the world’s largest asset manager, is adding bitcoin futures as an eligible investment to two funds, a company filing showed.
The company said it could use bitcoin derivatives for its funds BlackRock Strategic Income Opportunities and BlackRock Global Allocation Fund Inc.
The funds will invest only in cash-settled bitcoin futures traded on commodity exchanges registered with the Commodity Futures Trading Commission, the company said in a filing to the Securities and Exchange Commission on Wednesday.
A BlackRock representative declined to comment beyond the filings when contacted by Reuters.
Earlier this month, Bitcoin, the world’s most popular cryptocurrency, hit a record high of $40,000, rallying more than 900% from a low in March and having only just breached $20,000 in mid-December.
Bitcoin tumbled 10.6% in midday U.S. trading Thursday.
Other U.S.-based asset managers will likely follow BlackRock’s lead and add exposure to bitcoin in some form to their go-anywhere or macro strategies as the cryptocurrency market becomes more liquid and developed, said Todd Rosenbluth, director of mutual fund research at CFRA.
“It’s easy to see how strong the performance has been of late and look at a historical asset allocation strategy that would have included a slice of crypto and how returns would have been enhanced as a result,” he said. “Large institutional investors are going to be able to tap into the futures market in a way that a retail investor could not do.”
There is currently no U.S.-based exchange-traded fund that owns bitcoin, limiting the ability of most fund managers to own the cryptocurrency in their portfolios.
BlackRock Chief Executive Officer Larry Fink had said at the Council of Foreign Relations in December that bitcoin is seeing giant moves every day and could possibly evolve into a global market. (https://bit.ly/2XXFHrB)
(Reporting by David Randall; Additional reporting by Radhika Anilkumar and Bhargav Acharya in Bengaluru; Editing by Arun Koyyur and Lisa Shumaker)
Bitcoin slumps 10% as pullback from record continues
LONDON (Reuters) – Bitcoin slumped 10% on Thursday to a 10-day low of $31,977 as the world’s most popular cryptocurrency continued to retreat from the $42,000 record high hit on Jan. 8.
The pullback came amid growing concerns that bitcoin is one of a number of financial bubbles threatening the overall stability of global markets.
Fears that U.S. President Joe Biden’s administration could attempt to regulate cryptocurrencies have also weighed, traders said.
(Reporting by Julien Ponthus; editing by Tom Wilson)
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