Stocktake: Stocks propped up by buybacks binge

Stocks propped up by buybacks binge The US bull market is looking dangerously dependent on corporate buybacks.

Although the S&P 500 has soared, it seems everyone is selling.

Merrill Lynch last week noted clients had been net sellers for seven consecutive weeks; hedge funds and ordinary investors were reducing exposure, while net sales by institutional clients were the second-largest since Merrill began tracking data. Only corporations are buying, with share buybacks hitting six-month highs.

Worries about the sustainability of buybacks aren’t new, but the scale of today’s divergence is notable.


If investors continue to pull funds at their current pace, Bloomberg notes, the gap with corporate buybacks will be the widest in data going back to 1998.

Contrarians will note this has potentially bullish as well as bearish implications. After all, stocks have soared despite investor selling and mistrust; far from the rally being exhausted, it may be getting started if investors do an about-turn.

Still, bulls would surely prefer if the advance was fuelled by multiple sources.

As things stand, the rally is being supported solely by corporate buybacks in an uncertain economic environment where earnings are contracting. Market continues to improve Buyback data might suggest the rally's foundations are shaky, but the technical picture suggests otherwise.

It’s true that markets are extremely overbought. Last week, 91 per cent of S&P 500 stocks traded above their 50-day average; over the last 18 months, stocks have invariably dipped when readings hit such heights.

Additionally, 68 per cent traded one standard deviation above their 50-day average, according to Bespoke investment Group – a reading unseen since 2013.

However, market breadth has been extremely impressive.

Every S&P 500 sector hit two-month highs last week.

Small-cap and mid-cap stocks have outperformed, in stark contrast to the rally that petered out in December, when a handful of high-flying large-cap stocks masked underlying weakness.

None of the 2007-09 bear market rallies witnessed anything like the current momentum in market breadth, Fat Pitch blogger Urban Carmel noted last week; just one of the 2000-03 bear market rallies resembled the current advance.

In short, the technicals indicate any pullback is unlikely to be a bruising affair.

Bogle keeps eggs in US basket Indexing guru and Vanguard founder John Bogle really doesn't like international markets.

Bogle, who has long said American investors should stick to the US, cautioned last week that Britain may leave the EU, the Japanese economy is ageing and the French “don’t work very hard”. Stick with the US, which has a “fabulous economy”. Besides, US companies get half their revenues from outside the US: “You have an international portfolio, why do you want a larger one?”

Bogle’s complacency is misplaced.

US indices are more concentrated in technology sectors, so a US-only portfolio will be less diversified across industries. Ironically, Bogle is cautious on US valuations, warning last November that US indices would deliver annualised nominal returns of just 4 per cent over the next decade.

If the US is pricey – and it is – why not diversify? European stocks trumped the US in the 1970s, while Japan was the shining star of the 1980s. The US dominated the 1990s, suffered a lost decade in the Noughties, before leading global markets again since 2009.

Different regions dominate different periods, which is why home bias is such a dangerous practice.

Here’s some commonsensical advice for the author of the Little Book of Common Sense Investing: don’t put all your eggs in the one basket.

Collateral damage at Aryzta Aryzta chief executive Owen Killian is under pressure after dumping €16 million of stock last week, but he's not the only one with questions to answer.

The exact circumstances are unclear, but it appears Killian used his shareholding as collateral for personal borrowing, and was forced to sell after the value of his shares declined below a particular level.

Such cases hit the headlines periodically.

Last November, controversial Valeant chief executive Michael Pearson had to sell 1.3 million Valeant shares he had pledged as collateral. The chairman of Green Mountain Coffee Roasters lost his job after suffering a $123 million margin call in 2012. In 2008, a margin call forced the then chairman of Chesapeake Energy to sell almost his entire shareholding, once valued at $2 billion.

Unsurprisingly, pledging shares as collateral is increasingly frowned upon in the United States; many large companies prohibit it.

It may be time for a similar conversation in Ireland.