In early 2009, when the bull market began, a fair amount of financial commentators referred to the new upswing as a “bear market rally,” meaning they considered it to be a minor counter-trend move, which would eventually give way to the broader trend, which of course was downward. Obviously, the bull market has persisted, and is now one of the longest on record. This persistence, along with a steady expansion of multiples to levels previously associated with “bubble” territory, have contributed to a kind of cottage industry that has churned out myth after myth about the bull market, not least in regard to the sources of its energies, and the robustness of its duration.
The Corporate Buyback Myths
1. Recent Corporate Buying of Shares Is Anomalous
The popular site ZeroHedge recently published an article bemoaning the fact that since the bull market began in 2009, households and institutions (which largely act on behalf of households) have been net sellers of shares, while corporations themselves have been by far the biggest buyers of shares:
The article claims that petrified individual investors have been selling shares in droves, almost exclusively to corporations who have borrowed cheaply thanks to the Fed’s interest rate policies. While it is true that corporations have been the major buyers since the bull market began, the explanations given for it are categorically wrong, or at least misleading. In the first place, households and the institutions that serve them are almost always net sellers of shares. In the aggregate, households are generally net spenders, while corporations are almost always net savers. There is nothing at all unusual with households selling shares back to corporations. In fact, with few exceptions, that has almost always been the case going back to the early 1980s, when buying back shares became an approved tool of corporate policy.
2. Corporations Borrowing Is A Recent Phenomenon
It is certainly true that corporations have been borrowing heavily in recent years, using a good portion of the proceeds to buy back their shares. Again, however, this is completely normal corporate behavior. In the Anglo-Saxon corporate model, executives are employed by shareholders first and foremost to maximize shareholder value, and part of that is returning cash to them, generally in the form of dividends or buybacks. Obviously, issuing new shares dilutes the value of existing shares, and that is why corporations rarely issue new equity, and rarely retire debt. Furthermore, since interest expenses became tax deductible early in the twentieth century, corporations have had a large incentive to issue tax-favorable debt to fund operations versus diluting shareholder value.
3. Buybacks Have Fueled the Bull and Swelled Valuations
Because corporations have borrowed to buyback shares over the last ten years or so, many charlatans would have you believe that the entire bull market is essentially mirage fueled by easy money from central banks that have pushed up share prices and valuations. Again, this is far from the truth. While companies that perform shareholder-friendly buybacks tend to outperform over time (see here and here), there is little to suggest that buybacks have fueled the bull market.
For one thing, “demand” for shares is always neutral. For each buyer, there is a seller, and it makes no difference who the buyers and sellers are. Economist and fund manager John Hussman, of whom I have been a vocal critic in the past, sums this up very well when he writes:
“[S]tock prices don’t change because money goes “into” or “out of” the market. Prices change because buyers are more eager than sellers, or vice versa…But at the end of the day, all securities that were originally in existence are still in existence[.]”
Secondly, buybacks have little or no effect on valuations. Consider a comparison of the S&P 500 Buyback index with the S&P 500 index. The buyback index is composed of the top 100 stocks with the highest buyback ratios in the S&P 500, so it is a pretty good yardstick with which to assess corporate buybacks. Furthermore, it is equal-weighted, so its valuation characteristics are less distorted than broad indices with different compositions. That being said, it is notable that by every major valuation metric, the buyback index trades at a significant discount to the broader market:
If you are still not convinced, just look at the valuations of large companies such as Gilead Sciences or IBM, which have spent tens of billions on share repurchases, yet trade at well-below market multiples, while Tesla, a company notorious for large secondary equity offerings, trades at a significant premium.
The Fed Myths
1. QE and ZIRP Fueled Equity Gains
Another myth that will not die is that quantitative easing (“QE”), and zero-percent interest rate policy (“ZIRP”) have fueled the bull market since 2009. This is easily disproved. Fundamental factors such as robust profit margins and commensurate earnings growth have been the biggest contributors to equity gains, not easy money. If easy money were the main driver of equity performance, then areas of the world with proportionately larger central bank stimulus programs, like Japan, would have fared much better than areas with less stimulus. It is worth noting that the Fed ended its quantitative easing program in October of 2014, and ended its “ZIRP” program in December of 2015, yet the U.S. has outperformed both Europe and Japan (in dollar terms) since, despite much looser monetary conditions in those regions.
2. Low Rates Have Forced Savers Into Equities
The idea that low rates have compelled would-be savers into riskier assets is another myth that will not die. Human nature is more or less universal, so if this were the case, one would reasonably expect that negative interest rate policies in Europe and Japan would compel savers to empty their bank accounts and pile into equities at least to collect a modicum of yield. Yet this has not been the case. For example, equity ownership in Europe and Japan is little changed over recent years, despite the incentive offered by low rates to invest:
In most cases, the result of low rates has been for savers in these places to make up for lost interest income by saving more. This has certainly been the case in the U.S., with savings rates having leaped during the ZIRP years, as Dr. Ed Yardeni has noted:
All the while, equity exposure among American individuals is well below pre-crisis highs, having fallen from 62% to 54%, according to Gallup.
Perhaps because it was born in the midst of a crisis not seen in generations, and because it has coincided with unprecedented policies, the current bull market is perhaps the most misunderstood market cycle in history. However, when examined without bias, it is easily seen that much of the current cycle is really not all that remarkable, and that the skepticism surrounding it has, ironically, probably done more to fuel it than almost anything else. It will, like all previous cycles, end at some point, and the usual suspects will be there to cheer the selling, lauding a return to “price discovery.” It is doubtful, though, that their explanations for the new bear market will be any better than their shoddy rationale for the bull.
Disclosure: The results are hypothetical results and are NOT an indicator of future results and do NOT represent returns that any investor actually attained. Indexes are unmanaged, do not reflect management or trading fees, and one cannot invest directly in an index.
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