This stock market rally has everything, except investors

US companies are buying back their own shares in huge quantities, even as pension funds, mutual funds and other investors have been selling stock

Armchair investors have been selling stock. So have pension funds and mutual funds, as well as a whole other category of investors - nonprofit groups, endowments, private equity firms and personal trusts.

The US stock market is off to its best start since 1987, but these investors are expected to dump hundreds of billions of dollars of shares this year.

So who is pushing prices higher? In part, the companies themselves.

US corporations flush with cash from last year's tax cuts and a growing economy are buying back their own shares at an extraordinary clip. They have good reason: Buybacks allow them to return cash to shareholders, burnish key measures of financial performance and goose their share prices.

The surge in buybacks reflects a fundamental shift in how the market is operating, cementing the position of corporations as the single largest source of demand for US stocks. The binge has helped sustain a bull market approaching its 10th birthday, even in the face of political, international and economic uncertainty.

Since the market rally began in March 2009, the S&P 500 has risen more than 300 per cent as the United States recovered from the worst financial crisis since the Great Depression. But few expect those kinds of gains over the next decade. Facing the prospect of a period of relatively low returns - or even a bear market for stocks - many investors are eager to protect their gains or to find more appealing investments, like emerging markets and corporate bonds, outside the US stock market.

"There's no reason to be a hog," said Rich Robben, interim chief investment officer of the Kentucky Retirement Systems, which manages more than US$17 billion in the state's retirement and insurance funds. "We've all eaten at the public equity trough very well for 10 years now. And we felt it was just time to reduce that exposure a bit."

Reducing exposure

Mr Robben said his pension fund, which pays benefits to more than 100,000 retired state and county workers, has been cutting its stake in the domestic stock market for 18 months.

Such prudence paid off late last year, when concerns about a sluggish global economy, rising interest rates and slowing corporate profits hit the market. The S&P 500 fell 14 per cent in the fourth quarter, and 9 per cent in December alone. That was the worst monthly performance since February 2009, and badly shook investor confidence.

Since the worst of the sell-off - Dec 24 - the S&P 500 is up roughly 19 per cent. But data shows that many investors remain nervous: In every week this year, money has flowed out of domestic stock market mutual funds and exchange-traded funds - as much as US$15 billion in the last week of January, according to EPFR Global, which tracks flows into and out of funds. These investors, overwhelmingly individuals, have moved money into bonds and cash.

Henry Crutcher, a 44-year-old software company owner in Atlanta, has missed a bit of the rebound. He saw December's crack in the stock market as a buying opportunity and moved roughly 10 per cent of his portfolio from cash into a Russell 2000 exchange-traded fund. After enjoying a couple weeks of rising stock prices, he sold it, missing much of the roughly 10 per cent of additional gains that have come since mid-January. "Right now I'm partially invested," he said. "I'm not totally sitting on the sidelines. But I'm more on the sidelines than I think I should be."

Survey data suggests portfolio managers at many mutual funds and hedge funds have also been skittish about chasing the market higher. A survey of global fund managers by Bank of America Merrill Lynch this month reported that those holding more money in cash than usual outnumbered their stock-friendly counterparts by 44 percentage points - the biggest margin since January 2009. Such statistics suggest that many investors failed to capitalise on the sharp snapback in stocks early this year.

Corporations, however, don't seem to be experiencing such angst.In the fourth quarter last year, US companies bought an estimated US$240 billion of their own shares, according to an analysis by the Goldman Sachs team that handles stock buybacks for major companies. That's nearly 60 per cent higher than during the same period in 2017.

More buybacks are coming. Union Pacific railroad has bought nearly US$32 billion in its own shares since 2007 and this month authorised buying over US$20 billion more. Tech equipment giant Cisco has spent roughly US$20 billion on buybacks in the past year, and has authorisations to spend another US$24 billion. And Bank of America, which planned to buy US$20 billion of its own shares by the end of June, just added US$2.5 billion on top of that, the bank said this month.

Crucial benefits

Besides returning cash to shareholders, buybacks offer companies two crucial benefits. They increase demand for a stock, helping to prop up share prices. Buybacks also improve a key gauge of profitability closely tracked by investors and analysts: When a company buys back shares, the same profits are spread over the smaller number of shares still outstanding, improving their earnings-per-share number.

So far this year, companies have announced plans to repurchase a total of more than US$190 billion of their own shares. That is only slightly behind last year's pace of buyback announcements. And last year was a record for buybacks, as companies, in part thanks to the Trump administration's tax cut, gobbled US$910 billion of their shares, according to an analysis by Goldman Sachs.

Before the early 1980s, buying shares with corporate money was considered a legal grey area because it might open a company up to charges of manipulating its share price. In 1982, the Securities and Exchange Commission adopted a rule that allowed share repurchases, provided they followed certain rules.

Since then, stock buybacks have largely replaced dividends as companies' preferred way to return to shareholders the cash they can't spend productively. Shareholders like buybacks because they reduce the numbers of shares outstanding, which results in each remaining share being worth a bigger slice of the company. Taxes on buybacks can also be deferred until investors sell the shares, which are then taxed as capital gains.

While share buybacks tend to increase companies' share prices, critics blame them for stymieing corporate investment, hiring and wages. They argue that when a company spends its cash on buybacks, it leaves less money available for long-term capital spending and wages.

Supporters of buybacks argue, however, that companies won't make new investments or increase hiring if they don't see a profitable reason to do so. They contend that banning buybacks would simply result in higher dividend payments and corporate cash holdings or a surge in mergers and acquisitions.

A number of other factors - most notably the Federal Reserve's abrupt turn away from its clockwork pattern of interest-rate increases - have combined to restore confidence since the brutal sell-off that left the S&P 500 down nearly 20 per cent for the year on Christmas Eve.

The arrival of a solid, if unspectacular, batch of fourth-quarter earnings reports also quelled some investors' fears about the outlook for the global economy and corporate profits.

But the persistent flow of corporate money into the stock market has been a pivotal element in its recent rise.

"Buybacks are likely the No. 1 cause," said Brian Reynolds, an analyst at Canaccord Genuity, a Canadian asset management and brokerage firm. NYTIMES


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