The 3 Reasons Why Stocks Have Skyrocketed Over the Past Couple of Years

 

Stocks have soared because the Fed’s quantitative easing has – intentionallypumped them up.

They’ve also skyrocketed because the Fed and other central banks are directly buying stocks.

NBC News reports on a third major reason that stocks took off … corporate buybacks:

It’s the narcissist rally.

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You may want to spare a thought, and a healthy dose of worry, for what is one of the biggest, and least appreciated, reasons for the rally: buybacks.

Flush with cash and a world of opportunity at their doorstep, companies have decided there’s nothing more attractive than themselves. So, they’re offering big money to buy back their own stock. This year, big U.S. companies have given the go-ahead for $286 billion of buybacks, up 88 percent from the same period last year, according to Birinyi Associates, a market research firm. If the pace continues for the rest of the year, the tally will exceed the record set in 2007.

Every manner of company is caught up in the buying binge, including home-improvement chains, makers of farm equipment and jet engines, airlines, sellers of soft drinks and of hard liquor alike. Not one to miss a hot trend, Apple recently authorized as much as $50 billion of buybacks.

Investors like buybacks because they suggest companies think their stock is cheap. They also help reduce the number of shares outstanding, which automatically increases earnings per share. And higher earnings per share often, though not always, lead to rising stock prices.

But buybacks are also crucial to the rally for a reason that’s not widely known. Companies are one of the few big stock purchasers nowadays. Nearly every other big player in the stock market has been selling more than they’ve been buying.

Pension funds have been selling. Local and state governments have been selling. Investment brokerages have been selling. And, yes, until recently, even Main Street investors.

You can see this in the data released by the Federal Reserve each quarter, and it’s a sea of red — save for corporate buying, that is, buybacks plus purchases of other companies. In total, U.S. companies, not counting banks and other financial firms, have bought more than $1 trillion of stock in the five years through 2012, net of stocks they’ve issued.

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However much they spend, each dollar of buybacks appears to be having a greater effect on raising the prices of certain stocks. That’s because fewer shares are changing hands each day. On Wall Street, it’s referred to as a “drying up” of liquidity. And like in any market, a purchase or sale when fewer people are trading can push prices up and down much more.

DirecTV bought $1.4 billion of its own shares in the first quarter, or 7.8 percent of all trades in the company’s stock, according to data from Birinyi Associates. DirecTV rose 12.8 percent in the same period, two points more than the Standard and Poor’s 500. IBM bought $2.6 billion of its shares in the first quarter, or 5.6 percent of what was traded. It rose 11.8 percent.

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Companies that do buy back their own stock are seeing prices soar, and almost immediately.

On Friday, Northrup Grumman jumped 4 percent after announcing it had authorized $4 billion of buybacks. The military contractor said it expects buybacks will cut its shares outstanding by 25 percent by the end of 2015.

Another big share buyer, Home Depot, rose 5.7 percent on Feb. 26 after it announced a $17 billion buyback program. The S&P 500 rose 0.6 percent that day. If the retailer spends all the authorized in its plan, it will remove 18 percent of the shares outstanding at current prices, which will make the impact of a next round of purchases even more powerful.

Stocks of companies that have authorized the 10 biggest buybacks so far this year have risen 2.2 points more than the S&P 500 in the week after their announcements….

Gregory Milano, CEO of consultancy Fortuna Advisors, has run studies showing that companies that spend the most on buying back their own stock tend to underperform because they don’t spend enough on opening new factories, research or otherwise building their business for the long term.

Andrew Smithers, who runs a London-based investment consultancy, thinks buybacks have pushed stocks more than 40 percent higher than they’re worth. In his book “The Great Deformation,” former U.S. budget director David Stockman says Corporate America is drunk on buybacks and that they’ve helped push stocks up too far, too.

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Forty percent of the increase in the earnings per share of S&P 500 companies in the past 12 months came from reducing the number of shares through buybacks, estimates Barry Knapp, chief U.S. stock strategist at Barclays Capital.

Postscript:  Max Keiser points out that quantitative easing and corporate buybacks are related.  Specifically, the Fed’s easy monetary policy means that big corporations can borrow cheaply … and then use the money to buy back their own stock.

Of course, most of the trading is done by high frequency trading these days.

Category: Federal Reserve, Investing, Think Tank, Trading

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “Quantitative Easing, Central Bank Purchases and Corporate Buybacks Account for Much of the Rise In Stock Prices”

  1. Expat says:

    I was listening to The Last Resort while reading this article. I suggest you do the same.

  2. AtlasRocked says:

    * Bush & Obama choose NOT to prosecute all the banks, real estate and loan companies perpetrating “trillions of dollars of fraud” on the US citizens, as reported by 60 Minutes. They left all those crooks running our banks and property systems? Isn’t that racketeering? Holder admitted they didn’t prosecute the banks TO KEEP THE ECONOMY GOING! A trillion dollars of crime was allowed TO KEEP THE (debt based) ECONOMY GOING.

    * The governments, multiple governments, knew about the Libor scandal since 2007….and covered it up.

    * The FED made a gigantic mistake? Really? They didn’t know that holding interest rates too low would blow up? Way past the point the critics said it was creating a bubble? The 1929 crash was over extension of credit – a bubble – and they still don’t know what a bubble is [in real time]? And isn’t there abundant evidence the gov’t over-encouraged purchasing houses with loose loan oversite, crooked rating of MBS loan bundles, and encouraging both rich and poor to buy houses beyond their means?

    *Federal debt is rated different than industry debt, bonds. Industry requires proven, low risk future funding revenue streams to garner AA and AAA debt ratings. If a commercial company went to the bond rating company and told them they have been continuously accruing debt for the last 40 years, selling new bonds to pay off the old ones, they’d get junk rating. US debt is currently UNPAYABLE, in best case conditions. I have the analysis to back this up. It simply is not possible to pay the debt on existing tax revenues, EVEN IF TAXES ARE RAISED.

    ~~~

    BR: Edited for relevancy . . .

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  4. BenE says:

    You start by saying the fed has pumped the price of stock which is true, however the large amount of buybacks are a sign that relative to economic equilibrium the fed has not done enough.

    If there was sufficient fed liquidity and money was cheap enough, it would be worth it for companies to reinvest their money instead of giving it directly to investors.

    When people are turning assets into cash like that, it is a sign there is not a large enough supply of cash going around. That and high unemployment and falling inflation are all signs they desperately need to print more.

  5. denim says:

    Ya reckon the corporate insider trading by insiders is more lucrative with all the buyback activity?
    http://finance.yahoo.com
    http://insidertrades.org/

  6. Petey Wheatstraw says:

    “Postscript: Max Keiser points out that quantitative easing and corporate buybacks are related.”

    This entire analysis is screaming “Bubble!”

    Other than the fact that it’s different this time.

  7. Angryman1 says:

    lol, the only reason “QE” would make “stock market prices” rise is threw higher economic growth or less private sector debt……..

    What does that tell you then?

  8. odnalro zeraus says:

    Many have said that the Fed low interest rates created the bubble that blewup in 2009.
    The interest rates are lower than ever and we see the bull, but is it a bubble somewhere?