The only thing propping up the long-in-the-tooth bull market right now is a slew of aggressive share buyback programs. After a volatile year of mediocre earnings, the stock market, while volatile, still remains near record levels. But without legitimate, sustainable earnings growth, the bull market is doomed. Corporate America can only cook their earnings with near-record-high share buybacks for so much longer. Eventually, investors will need to face the fact about the underlying fundamentals of Wall Street.
This Is the Only Thing Holding Up Wall Street
The current bull market recently celebrated its seventh anniversary. Since the markets bottomed in March 2009, the S&P 500 has soared close to 200%, while the Dow Jones Industrial Average is up more than 160%.
Celebrations for the third-longest bull market in history were a muted affair. And for good reason. It’s all smoke and mirrors. Earnings and revenue have been underwhelming for a long time now, yet miraculously, the broader markets, while volatile, still remain near record levels.
In a world without unicorns and leprechauns, investors reward companies that post strong revenue and earnings growth with higher stock prices and punish those that underperform. But this isn’t happening. Or at least it doesn’t appear so on the surface.
Despite abysmal quarterly results, the markets have been surprisingly resilient. The year started off poorly with the S&P 500 losing more than 10% of its value in the first two months of the year on fears of a weakening global economy. Since the middle of February, however, the S&P 500 has bounced back, climbing more than 10%. Why the optimism? Nothing has changed materially.
In addition to blind investor optimism, the stock market is being propped up by corporate buybacks. Buybacks have essentially been responsible for keeping the flat-lining bull market alive for a long time.
According to the most recent data, in the third quarter of 2015, corporate America repurchased $156 billion worth of shares. This represents a quarter-over-quarter increase of 16% and a year-over-year increase of 6.4%. (Source: “Buyback Quarterly,” FactSet, December 15, 2015; http://www.factset.com/websitefiles/PDFs/buyback/buyback_12.15.15.)
How did that $156 billion in share buybacks affect earnings?
The dollar amount spent on share buybacks for the trailing 12-month period ended October 31, 2015 represented 64.6% of net income. In the trailing 12 months ending in the third quarter, 130 companies spent more on buybacks than they generated in net income. This represents the biggest percentage since October 2009, when buybacks made up 74.8% of net income.
Record Buybacks Propping Up Stock Market
In the first quarter, it is estimated that S&P 500 companies will repurchase as much as $165 billion of stock. This is getting very close to the record $171 billion purchased in the third quarter of 2007. (Source: “S&P 500 Buybacks,” S&P Indices web site; http://ca.spindices.com/indices/equity/sp-500, last accessed March 14, 2016.)
At a time when S&P 500 companies are gobbling up their own stock at a near record pace, clients of mutual funds and exchange-traded funds are running for the exits. Since January, they have pulled out more than $40.0 billion. If the current pace continues until the end of March, withdrawals could hit $60.0 billion, making it one of the biggest quarterly withdrawals ever. That implies a gap with corporate stock repurchases of $225 billion—the widest chasm since 1998. (Source: “There’s Only One Buyer Keeping S&P 500’s Bull Market Alive,” Bloomberg, March 13, 2016.)
How long can corporate America continue to prop up the bull market in the face of falling profits? In the just completed fourth quarter, the blended earnings decline for S&P 500 companies was -3.3%. The third straight quarterly decline in profits represents the longest losing streak in six years. (Source: “Key Metrics,” FactSet, February 26, 2016; http://www.factset.com/websitefiles/PDFs/earningsinsight/earningsinsight_2.26.16.)
The streak will continue. The estimated earnings decline in the first quarter of 2016 is -8.3%. A sharp divergence from the December 31, 2015 earnings growth guidance of 0.3% issued at the start of the quarter. (Source: “Earnings Insight,” FactSet, March 11, 2016.)
Of the 117 S&P 500 companies that have issued earnings-per-share (EPS) guidance for the first quarter, 91 (78%) have issued negative EPS guidance—well above the five-year average of 73%. All 10 sectors of the S&P 500 have lower growth rates today when compared to December 31, 2015 due to downward revisions to earnings estimates led by the energy sector.
If the S&P 500 reports a decline in earnings in the first quarter, it will represent the first time the index has seen four consecutive quarters of year-over-year declines since the fourth quarter of 2008 through the third quarter of 2009.
Corporate America cannot continue to support its own share prices. The buyback revolution cannot continue unabated. Investors want to see real, sustainable growth. This may not be possible in the midst of falling profits—and rising interest rates.
The era of cheap money and financial manipulation is coming to an end. Just like the bull market.