US corporate stock buybacks remain the most important source of demand for domestic stocks. But what happens to them during the next recession?
DataTreks 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 dont go to zero.
Here is the article, reprinted from his daily newsletter:
There is a maxim in medicine known as Suttons Law, which basically says a doctor should first consider the most obvious diagnosis for a patients complaint. Its name comes from bank robber Willie Suttons best-known quote. When asked why he robbed banks, he reportedly replied, Because thats 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 wont go away in a garden-variety recession. Something deeper, like a 2008-2009 rerun, and all bets are off. But if that happens well likely have bigger problems anyway.