Though we have experienced extreme volatility in 2018, every sell off has been short lived. In fact, the past five years has been this way. The S&P 500 has experienced only two negative quarters since 2013. One constant throughout has been the elevated levels of stock buybacks. While buybacks play a role in markets, the question is how much is too much and what are the risks associated?
Prior to 1982, stock buybacks were a rare occurrence as corporations ran the risk of being prosecuted by the SEC. After a few regulatory tweaks, stock buybacks became the norm. Corporations turn to buybacks when they feel their stock is undervalued and attempt to put a floor on the price. They can use cash on their balance sheet or borrow money (debt) to do so. Leading up to the financial crisis, buybacks were steadily increasing year over year. All that changed in 2008 when the global economy came to a screeching halt. After the Federal Reserve stepped in and reduced interest rates and began quantitative easing, corporations took advantage of low interest rate and once again began to ramp up buybacks. Just recently, as part of President Trump's tax overhaul, corporate taxes were reduced from 35% to 21%, which lead to a new surge in buybacks. Through February 15th, corporations had announced over $170 Billion of buybacks. This surpasses the $147.2 billion in the first six weeks of 2015 and nearly double the first six weeks of each year since 2011 (minus 2016). Over the past decade, the corporations that comprise the S&P 500 have spent 54% of their profit on stock buybacks. This is a jaw-dropping amount and makes one wonder how sustainable it is.
The question is, are stock buybacks healthy or more a temporary solution? Proponents argue that too much is harmful as it mainly enriches shareholders and corporate executives and does not focus on capital investment, spending or boosting wages, which help all, not just the few. History has shown that achieving sustainable economic growth is extremely difficult without a growing lower and middle class. Also, oftentimes struggling corporations issue buybacks in an attempt to stop the bleeding while ignoring their fundamental problems which leads to a poor use of resources. While buybacks may help boost corporations' earnings per share, it has no material impact on bottom line growth. This is important to remember as many stocks experienced phenomenal gains leading up the financial crisis when in reality their growth was already slowing but buybacks were helping cover up the root of the corporations problems. Stock buybacks are rarely subject to shareholder approval which means the board of directors has the final decision. To be clear, buybacks serve a purpose (similar to dividends) and make sense when implemented properly but just like most thing, too much of it could be detrimental the same way too much lending or debt can be harmful.
On one extreme we now have lawmakers proposing bills to ban buybacks completely. While this seems extreme it is something we may start hearing more about. A majority of voters don't have investments and in some ways love the idea of "hurting Wall Street" in whatever way possible.