Saturday, October 13, 2007

Buybacks Continue at Record Pace

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I mentioned in an entry 2 weeks ago "Buybacks are all the Rage - is the Market Inevitably Going Up in the Long Run?" the unprecedented pace of corporate buybacks.

Is the market simply destined to go up because we don't have enough stock for people to invest in? Basic economics - supply (of stock) shrinking, demand steady (or rising), prices must go up.

Do you realize the level of buybacks that have been going on? Not announced buybacks but tried and true "after the fact" reporting of buybacks is
>$100 BILLION for 8 quarters in a row. It has accelerated lately... $118 Billion in Q1 2007, and $158 BILLION in Q2 2007. Even if we drop back to low $100s for Q3 and Q4 2007 that is an annual buyback binge of just under $500 Billion. On top of that is 6 previous quarters (back half of 2005 and 2006) of another $600 Billion+. So this is $1.1 Trillion of stock value that will be taken out of circulation by year end 2007.

So last quarter alone (Q2 2007) companies bought back $158 Billion of stock. Now that was of course mostly done by the largest companies in the US (the true mega caps with >$100 Billion market cap) but it doesn't matter WHO is retiring this equity, it simply matters that it is being retired from the market as a whole. And when it is retired that means SUPPLY of stock in the US as a whole is falling.

So if we retired on average say $110 Billion a quarter, that is essentially saying we are eliminating 10 huge companies the size of 200th largest stock in the US (market cap $11.8 Billion) So supply of stock equal to 10 of those companies are disappearing each quarter; or 40 a year.

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I have been looking for third quarter data of what "actually" happened (i.e. announced buybacks are very different from actual stock bought) and I have not found it yet but I found this weekly analysis via Forbes.
  • In recent quarters, the supply of shares has been plummeting, which is extremely bullish. In the third quarter of 2007, the float of shares (L1) dropped by $4.0 billion daily, the second-highest amount of float shrink in any quarter in our records.
  • L1 has dropped by at least $2 billion daily in each of the past six quarters. With so many shares being sucked out of the U.S. stock market, is it any wonder that the S&P 500 rose in nine of the past 10 quarters?
  • During the week ended Thursday, Oct. 4, the float of shares (L1) dropped by $13.3 billion, the second consecutive decline exceeding $10 billion. Announced corporate buying was strong across the board. New cash takeovers leaped to a 10-week high of $11.7 billion, and 20 new stock buybacks totaling $6.3 billion were announced.
  • On the other side of the ledger, new offerings totaled a paltry $3.2 billion, which remained lower than our upfront estimate of $6.0 billion. New Offerings have been below $5 billion for eight consecutive weeks.
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These numbers are very important to me; and I think will become even more important as the mainstream media wakes up to it. I have even seen Cramer start talking about it in the past few weeks. Just last week you had pretty shoddy earnings by Alcoa but they upped their buyback program from 10% of all shares to 25% of all shares - which for a $33 Billion market cap company would be a $8.25 Billion share retirement. Again, $8.25 Billion represents the size of a company in the range of 200-250th largest in the US. So Alcoa alone will have eliminated one of the SP500 companies if it follows through; and one in the upper half of the index at that.

This pace is relentless, week after week as large cap companies rake in cash, and not enough new stock supply coming onboard to offset this. So even in an environment where demand is flat, this would bode well but with increasing money supply this shifts the supply/demand dynamic even more favorably towards higher prices.

I have been thinking that since the August 2006 low, the market's pace of gains have been eerily consistent (the word I use is 'relentless'). I prefer choppy markets to be able to sell, and then buy back lower but for the better part of 15 months when the market was on the good side, it's been a steady drip upward with little downside volatility. Outside of 'shocks' (a) about 3 weeks in Feb/Mar 07 when Shanghai fell 8% and spooked the markets and (b) this summer's credit 'surprise' the move upward week after week/month after month has been steady - more steady than I can remember in past years when you'd have 3 months up, than 6 weeks down, 2 months up, 3 weeks down - and maybe this is just 1 person's memory playing tricks on him but I remember reading articles about "record amount of weeks the market has gone without a 2% correction" back in the winter. This period also marked the peak of the private equity binge so you have yet another force taking stock off the market.

Once again, since our last shock the move up has been relentless and steady once we left the "short covering" stage. Now again this does not mean we won't have pullbacks but they seem to be violent and relatively short, versus periods in the past when we'd actually have 3-4 months of choppiness, or heck sideways with no trend, in the past. The past 15 months have been more of a up, up, up, for months on end followed by violent few week period down, following by up, up, up, up for months on end, violent few week period down, etc. Could it be as simple as supply/demand rules? Could this be why so much money is flowing into hot sectors and buoying them to levels past where people would think logical? With so few sectors working and X amount less stock available each week, the winners are going to take in more and more available dollars since there is no place else to park cash.

Something to keep a close eye on in the coming years - the companies with the deepest pockets are those large cap and mega caps who will still benefit greatly from global expansion even in the face of a slowing US - so they can continue to plow back cash into taking shares off the market, whether the US economy slows or not. And our pullbacks will be shorter in duration, rarer in nature, and perhaps more violent as the movement down is compressed into weeks versus months. Perhaps.

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