In what comes as a very worrying announcement for investors, Goldman Sachs has just said that it may be time to cash out of equities. Goldman says that the current mass rotation out of equities and into bonds mirrors what happened before the Crisis. “Decelerating US economic growth, trade and geopolitical uncertainty, and near-record high starting equity allocations have likely contributed to the rotation from equities to bonds and cash this year”, says Goldman. Any steadiness in equities will probably just be artificial. “The peak in buyback activity arrived in 2018 after the Trump administration’s tax cut fueled a wave of repurchase programs. Buybacks are projected to fall 15% in 2019, and drop another 5% in the following year”, Goldman said.
FINSUM: In principle this seems like a sound assessment. The problem is that all the worries Goldman is citing have been on the table for a while and yet stocks have been rising.
Retail investors are fleeing the stock market, yet it keeps rising. What gives? Bernstein Research just studied this situation and had some interesting findings. Firstly, retail investors’ rotation of out stock funds and into bond funds has been the largest in history, with $1.1 tn flowing out of stocks and into bonds in the last 12 months. Secondly, they found that none of that really matters given the current state of markets, which are being driven by buybacks and M&A. Finally, they found that such outflows are usually a very bullish sign and they generally signal over-pessimism and have often been followed by great returns.
FINSUM: This seems like a very solid counter indicator that things might start turning more positive.
Buyback stocks have developed a poor reputation recently. Stock buybacks are seen as financially irresponsible and a way for executives to manipulate earnings and share prices. While that may be true to a degree, they also happen to be a great way for companies to return money to shareholders. Additionally, and what is not well understood, is that buyback stocks have a great track record historically. Since 1995, the one hundred S&P 500 stocks with the highest level of buybacks have significantly outperformed the index, earning a 13% return versus the index’s 10%. The same is true for the Russell 3000, so it is not just a case of buybacks working for large caps.
FINSUM: Yes, buybacks may be at their highest total levels historically, but they are flat as a percentage of earnings, so buying hasn’t been any less conservative than in the past. The other good thing is that buyback stocks are usually cheaper than average.
Beyond high valuations and a potentially worrying economy (not to mention a trade war), there is something else investors need to worry about. Goldman Sachs is warning investors that S&P 500 companies are engaging in unsustainable financial payouts. The bank shows that in the year ending in March, companies in the index spent about 104% of their free cash flow on buybacks and dividends. It is the first time since before the Crisis that companies spent more on payouts than they generated in free cash flow.
FINSUM: So far this behavior is not hurting companies because investors are okay with extra leverage given the likelihood of Fed easing, but this is definitely a warning sign of financial excess.
Something the market has not had to deal with for some time is once again occurring. That change? Slumping buybacks. Hiked dividends and big buybacks have been staples of the this historic bull run, but the latter are starting drying up. Share repurchases shrank for the first time in seven quarters in the second quarter. The total amount of buybacks—over $200 bn—is still quite robust, but it is a sign that companies are tightening up, which could be indicative of the overall direction of the economy.
FINSUM: This is immaterial. In 2018, companies spent $800 bn on buybacks, so $205.8 bn (the 2nd quarter’s figure) is actually ahead of pace.