Stock Market: If You Take This One Thing Out, Stocks Crash

Stock MarketWho or what is supporting today’s stock prices? Well, it’s not retail investors. As mentioned in these pages earlier this week, retail investors have withdrawn $17.0 billion from stock mutual funds in the past two months! And institutional investors aren’t buying stocks either, as they have been selling stocks, too, and increasing their bearish bets on the stock market.

As for corporate insiders, the executives who work at public companies, they have been dumping stocks like hot potatoes. On January 1, the insider sell-to-buy ratio stood at 8.49. That means that for every one share they purchased, insiders sold 8.49 shares. As of March 11, this ratio stood at a whopping 20.79! Insider selling has increased by 144% in a matter of a few months. (Source: Insider Rate Reports, last accessed March 14, 2016.)

Personally, I get worried when insiders sell stocks in the companies they work for. Does that mean they do not have faith in their company’s future revenue and earnings capabilities?

Dear reader, there is only one thing holding up stock prices right now and its corporate stock buyback programs.

Consider this: In the first quarter of 2016, S&P 500 companies are on pace to buy back the largest amount of stock since 2007. (Source: Bloomberg, March 14, 2016.) So it’s not investors creating the demand for stocks; it’s the companies that issue the stocks! In the current quarter, corporate America is buying back stocks at an unheard pace of almost $3.0 billion worth a day!

What Does This All Mean for the Stock Market?

For starters, you must understand that companies have limited resources (cash). Over the past few years, thanks to the Federal Reserve’s policies, corporate America was about to borrow money cheaply and use that money on stock buybacks. Yes, it was that ridiculous and it was ignored completely.

But how much money can companies borrow? And how much stock can they buy?

The reality is this: Stop the corporate buyback programs and there is no support for stock prices, hence stocks drop in value without demand. The valuations of stocks, given consecutive quarters of contracting revenues and earnings, are far too stretched. The stock market is a ticking time bomb.

The rally in stock prices over the past few weeks is simply a bounce from severely oversold stock market conditions (remember the Dow Jones Industrial Average shed 2,500 points between November of 2015 and mid-February of 2016). I believe stock prices are headed much lower in 2016 and that a stock market crash is still a possibility in 2016. Capital preservation could be the best investment strategy for investors right now.

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