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The Stock Market Is in for a Rude Awakening Thanks to This $364 Billion Drag

Last Updated September 23, 2020 1:48 PM
Laura Hoy
Last Updated September 23, 2020 1:48 PM
  • Share repurchase programs will see a significant reduction across the board in 2020.
  • That removes an important layer of stability that’s propped the market up for the past decade.
  • Buyback suspensions could drain $364.5 billion from the stock market.

The U.S. stock market has enjoyed some spectacular rallies over the past week as investors reveled in optimistic data showing coronavirus cases in hotspots around the world appear to be peaking.

But is this a light at the end of the tunnel or an oncoming train? Many analysts warn that the latter is about to crush this recovery.

Why Earnings Season Will Tank the Stock Market Rally

stock market
Earnings season will likely deliver a devastating blow to the stock market as investors process the magnitude of coronavirus damage. | Source: Spencer Platt/Getty Images/AFP

Earnings season kicks off next week, which could be a painful reminder of just how devastating coronavirus has been on the U.S. economy. The upcoming quarterly results could erase the past few weeks of gains  as reality sets in.

Strapped for cash, many U.S. firms are suspending buybacks in an effort to preserve liquidity. That, according to Goldman Sachs, could pull the rug out from under investors who are expecting this rally to continue.

The past decade saw an unprecedented number of buybacks, which put a floor beneath share prices. That’s coming to an end, according to Goldman, who sees buybacks declining by 50% in 2020. That means $364.5 billion in buying pressure could evaporate from the stock market this year. 

Our quarterly review of S&P 500 earnings transcripts consistently reveals that management teams view buybacks as the lowest priority use of cash. A spate of recent suspensions, escalating employee layoffs, and increasing political and social pressure will curtail buyback spending, which remains historically elevated following the passage of corporate tax reform.

Buybacks Remove an Important Market Floor

Brian Reynolds of Reynolds Strategy says his research shows that corporate buybacks have injected $4 trillion into the U.S. stock market over the past decade. What’s more— that’s the only net source of funds  the stock market has seen since 2008 when the financial crisis ended. Without that pillar of support, the market’s volatility will be amplified.

It’s going to be like riding a bucking bronco in the stock market for the next six months

In 2019, S&P 500 companies injected $729 billion into the market through share repurchases. This year was expected to see just as much – if not more – buyback activity. But the economic impact of coronavirus has completely upended that forecast.

stock market buyback chart
Stock buybacks have been an important pillar of support for the market. |Source: WSJ 

Stock Buybacks Are a Powerful Stock Market Driver

Merger and acquisition activity also plays a powerful role in removing shares from the stock market and driving prices higher, but buybacks remain one of the biggest contributors to the decade’s bull market.

In 2019, stock buybacks accounted for about 3% of the S&P 500’s total market value.  

stock buybacks will decrease as economy turns lower
The suspension of bank buybacks alone will be a major blow to the U.S. stock market. | Source: Financial Times 

Banks have already announced plans to suspend buybacks, which removes a huge number of buyers moving forward. Bank of America (NYSE:BAC)  alone spent $7.7 billion on stock buybacks as of December 2019.

u.s. airlines gorged on stock buybacks
Airlines have been pumping cash into markets at an alarming rate over the past ten years. | Source: Bloomberg 

Airlines, who will likely be prohibited from conducting buybacks under the CARES Act, spent 96% of free cash flow  buying back shares over the past ten years. United Airlines (NYSE:UN) repurchased over $12.5 billion worth of shares.

Removing buyers from the stock market is a recipe for disaster. Corporate buybacks make up a huge proportion of the market’s buyers, so their sudden elimination will be detrimental to the market’s stability going forward. 

Disclaimer: This article represents the author’s opinion and should not be considered investment or trading advice from CCN.com.