Share Repurchase Fever
After a market rally that has lasted more than a half a year bullish sentiment recently reached the types of extremes seen once every few years. It used to be the case that this type of extreme sentiment would be a reliable indicator for an intermediate term market top. However, that does not seem to be the case this time around. The market pulled back for three days and now seems to be resuming its rally this morning. I believe the reason for this behavior is the historic level of stock repurchases we are seeing. From Bloomberg:
About 79 percent of buyback orders at Goldman Sachs Group Inc.’s corporate trading desk were active yesterday, the most this year, according to a note to clients obtained by Bloomberg News. Companies stepped up purchases as the Standard & Poor’s 500 Index fell as much as 3 percent from an intraday record reached May 22.
The buybacks may have limited losses in American equities after shares in Japan fell the most in two years and stock markets from London to Paris and Frankfurt saw declines of more than 2 percent.
In the current market environment it is crucial to monitor share repurchases. Here are some things to be on the lookout for:
- A change in the economic or interest rate backdrop that slows the pace of share repurchases.
- As prices rise it takes an increasing amount of share repurchases to have the same effect. We could reach a point where share repurchases produce diminishing returns, although we do not seem to be there yet.
- Insider selling and share issuance begins to outpace the share repurchases and cash M&A.
I used last week’s decline to take in many of the shorts I had been scaling into and am now very modestly net long. The reason I did so was that it seems futile to fight these share repurchases, even though I believe the market has gotten ahead of itself.