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Stock Buybacks Are Plummeting. Should Investors Worry?

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For years the U.S. stock market has been heavily supported by share buybacks and accommodative monetary policy. Now the easy monetary policy is ending as the Federal Reserve raises rates and prepares to unload many of the securities it bought during its quantitative easing program to boost growth, and the number of buybacks is falling substantially.

(Related: Fed Raises Rates, Lays Out Plan to Cut Balance Sheet)

Just over half the companies in the S&P 500 reduced their share count in the first quarter of this year, down sharply from 324 companies in Q1 2016, according to S&P Dow Jones Indices. Most important, the number of companies that cut their share count by 4% or more — considered a key level to boost earnings — fell to 71 in the first quarter, down 49% from the first quarter of 2016 and 24% below the count in the fourth quarter of 2016, according to Howard Silverblatt, its senior index analyst.

He added that the 20% of the S&P 500 companies that cut the share count by 4% over the last 2.5 years also saw their share price rise by 4%.

Buybacks could fall even further during the second quarter of this year compared to the first, which means “they may have to increase EPS the old-fashioned way — by earning it,” says Silverblatt.

He’s not concerned that support from buybacks, which have been criticized as a prime example of financial engineering, is declining. “This is telling me that companies are feeling confident with the second quarter, not needing buybacks to increase gains.”

Declining buybacks are like rising rates, according to Silverblatt. They may appear to be negative, but if rates are climbing because the economy is strengthening (rather than inflation soaring) that’s positive. “If earnings were not getting better, companies would be increasing their buybacks,” says Silverblatt. “They have the money to do it.”

But they don’t have the need to because “earnings are growing on their own,” says Steven Chiavarone, portfolio manager of the Federated Global Allocation Fund. “They don’t need as much financial engineering. Companies have cash and may have even more cash” if and when tax reform allows for repatriation of overseas assets at lower than current tax rates, he says.

Congress is not expected to pass any tax reform bill until later this year, at the earliest, so it’s unlikely any tax change that would lead to repatriation will take effect until some time in 2018.

As of the first quarter, just under 15% of the S&P 500 bought back 4% or more of the shares — the lowest percentage in at least three years and roughly half the percentage just a year ago. Moreover, buybacks were concentrated, with the top 20 companies accounting for just over 42% of all share purchases. Apple led on buybacks for the first quarter and year-to-date through Q1.

Technology, financials and health care have been the top three sectors for buybacks, accounting for 20% to 22% of buybacks in at least the last two quarters.

Chiavarone says the decline in buybacks represents a “healthy transition to actual earnings growth,” which would only cause a problem if revenues slow “materially.”

If companies do well in the second-quarter earnings season, which gets underway in earnest in mid-July, concerns about P/E multiples being too high will decline, according to Silverblatt.

He says the upcoming earnings season is a lot more important than past earnings seasons because companies won’t have the same level of support for share prices as a result of the decline in buybacks. He expects a record earnings season for the S&P 500 with operating earnings at $31 per share.

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