Investors have been selling off their public equity portfolios, but the stock market doesn’t seem to show it. That’s because companies have been offsetting the selling by buying back their own stock, taking it out of circulation and pushing up prices, according to one analyst.
“Essentially, this bull market has pitted investors, who have been lukewarm at best, against companies buying back their stock,” Brian Reynolds of Canadian investment bank Canaccord Genuity wrote in a note to clients Monday. “From time to time, investor selling has produced some brief drops in stock prices in the last nine years, but these episodes have been brief and eventually overwhelmed by company buybacks.”
[II Deep Dive: The Grouchy Investor Epidemic]
Canaccord Genuity analyzed the Federal Reserve’s flow-of-funds data for the first quarter of 2018, which confirmed the bank’s view of the dynamic behind market corrections during the period. Reynolds wrote that corporate pension plans, public pensions, households, and hedge funds were net sellers in late January, even though the stock market rose beyond expectations for the time period. Companies bought back their stock, creating enough demand to push equity prices up and thus mute the effect of selling by investors.
“Offsetting these declines was an increase in net buybacks from companies, confirming that buyback growth rates change in response to stock market drops and surges,” Reynolds wrote.
Canaccord said that market activity in the first quarter reflected larger buying and selling patterns that have emerged since 2009. Companies are the biggest buyer of U.S. stocks, outpacing exchange-traded funds, foreign buyers, mutual funds, brokers, pensions, hedge funds, and individuals combined.
Reynolds explained that since the advent of the high-yield bond market in the 1980s, there has been a huge shift in market dynamics. Before the junk bond market opened, companies sold stock to raise money and reinvested those funds into their businesses. Now publicly traded companies tap debt markets for capital and use the money to buy back stock.
“The first quarter did not change this dynamic and, with the credit market continuing to provide capital to companies, this buyback-fueled equity bull market is likely going to persist for a number of years,” according to Reynolds.