What Will Happen to Corporate Buybacks if a Recession Hits?
Traders Magazine Online News, November 20, 2018
US corporate stock buybacks remain the most important source of demand for domestic stocks. But what happens to them during the next recession?
DataTrek’s co-founder Nicolas Colas examined in a recent newsletter that the short answer is that public companies routinely spend 40-60% of their operating income on buybacks, only breaching the low end of that range during the direst times. A 30% decline in earnings may mean an equivalent decline in buybacks. But they don’t go to zero.
Here is the article, reprinted from his daily newsletter:
There is a maxim in medicine known as “Sutton’s Law”, which basically says a doctor should first consider the most obvious diagnosis for a patient’s complaint. Its name comes from bank robber Willie Sutton’s best-known quote. When asked why he robbed banks, he reportedly replied, “Because that’s where the money is.”
- US corporates in the S&P 500 Index have repurchased $3.8 trillion of their own stock since 2010.
- Buybacks for the last 12 months ended June (latest data available) total $646 billion, the largest run rate ever.
- Buybacks have totaled +$100 billion every quarter since Q2 2013.
- To put some perspective around these numbers, consider that 2018YTD inflows into US large cap equity ETFs are just $26.5 billion.
- Corporate buybacks peaked in the prior cycle at $589 billion (the 4 quarters of 2007).
- Buybacks then dropped by 77%, bottoming during the 4 quarters of 2009 at $138 billion. Yes, just when US equities were cheapest…
- One year later, buybacks had more than doubled to $299 billion for the 4 quarters ending December 2010.
- Between 2010 and 2017, S&P 500 companies allocated an average of 51% of their operating earnings on buybacks. This year is higher, at 59% through the first half.
- Assume, for example, a 30% decline in current corporate earnings from a recession that starts early in 2019.
- This would take S&P 500 operating earnings from $1,200 billion currently to $840 billion in 2019.
- Buybacks might drop to 45% (similar to 2010) of that lower earnings number, or $378 billion. Nowhere near their trailing 12 month run rate of $646 billion, to be sure. But more than enough to absorb some of the selling that would come with a recession.
There might be a quarter or two of lower buyback/earnings percentages (which would mark a bottom), but once conditions stabilize managements would step back in.
The bottom line: yes, buybacks are very important to market dynamics, but no - they won’t go away in a garden-variety recession. Something deeper, like a 2008-2009 rerun, and all bets are off. But if that happens we’ll likely have bigger problems anyway.
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