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.
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.
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.
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.
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.
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.