The S&P 500 continues to break out to new – and newer – highs. Buybacks have provided a sustained tailwind, although interesting dynamics are in play for next year.
Yet another week, yet another record and yet another breakout!
Last Wednesday, the S&P 500 staged a fresh breakout at 5760s, followed by Thursday’s successful doji retest, ending the week up 1.1 percent to 5815. This was the fifth up week in a row. Previously, the large cap index on September 19 broke out of 5670s, which represent the prior highs from July 16 (5670) and September 17 (5671); a successful retest took place in the very next session and then again on October 2-3.
Year-to-date, the S&P 500 is up 21.9 percent. This follows a 24.3-percent jump in 2022 and a 19.4-percent drop in 2021.
Bulls carry the momentum, although the index has failed to rally sharply past a rising trend line from the low of October last year (Chart 1). October (this year) is just short of halfway through, and the index is up 0.9 percent. If the month ends positive, this will be an 11th up month in 12.
The daily is beginning to get extended, but until the bears succeed in reclaiming 5670s, they will be on the back foot.
Buybacks have provided a reliable tailwind for equities.
In 2Q20, as Covid-19 was wreaking havoc on the economy, buybacks by S&P 500 companies dwindled to $88.7 billion – an eight-year low – before picking up steam. By 1Q22, buybacks reached $281 billion, which is yet to be surpassed. In the June quarter (this year), these companies spent $235.9 billion, down slightly from the March quarter’s $236.8 billion.
The ongoing positive momentum can be ascertained by the fact that buybacks totaled $877.5 billion in the 12 months through June – a six-quarter high (Chart 2) – up eight percent from a year ago. This is quite healthy, except that the S&P 500 is doing much better. Through June, the index was up 22.7 percent from a year ago. This obviously reduces the number of shares purchased as buybacks are taking place at higher prices.
One reason companies buy back shares is to offset dilution from employee stock options and grants. This particularly applies to tech companies. In the June quarter, the top four spenders were all tech – Apple ($28.8 billion), Google parent Alphabet ($15.7 billion), Facebook parent Meta ($9.5 billion) and Nvidia ($8.8 billion). Collectively, these four accounted for 26.6 percent of the total, with the top 20 equaling 52.2 percent. Things are top-heavy.
Here is the irony in all this. Because the S&P 500 is on pace to rally north of 20 percent for the second year running, a rising percent of these options is in the money. If the employees rush to exercise their options, companies will need these shares. So, buybacks can remain healthy in the quarters to come. This is one side of the coin.
The other is the buyback tax. The Inflation Reduction Act of 2022 introduced a one-percent excise tax on share repurchases of over $1 million. If post-presidential election, this tax goes up next year, managements may have a decision to make – between continuing with share repurchases or shifting some of this money to dividends. Incidentally, we need to go back to 1Q10 to see one-year total of dividends outpacing one-year total of buybacks. Otherwise, buybacks have been handily beating dividends – $877.5 billion versus $603.3 billion, for instance, in the 12 months to June this year. This likely continues in the quarters to come, but the dynamics between employee option exercise and the buyback tax has the potential to make for interesting times ahead.
Thanks for reading!
