NEW YORK — It’s the narcissist rally.
Sure, there are plenty of forces pushing stocks higher — record corporate earnings, small investors finally buying again, signs the U.S. economy may be strengthening, central banks flooding the financial system with money.
But 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.
- McMorris Rodgers should ask hometown folks about Obamacare
- Seattle congestion: We're No. 5
- Expedia expected to announce Seattle move
- Seahawks re-sign FB/DL Will Tukuafu
- Seattle traffic congestion: We're No. 5
Most Read Stories
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.
DirecTV bought $1.4 billion of its stock in the first quarter, or 7.8 percent of all trades, according to data from Birinyi Associates. It rose 12.8 percent in the same period, two points more than the Standard & 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.
The total amount of buybacks doesn’t appear to be enough to have a big effect on the whole market. If companies in the S&P 500 follow through on their plans this year, the buybacks will amount to just 1 percent of total trading, estimates Robert Leiphart, an analyst at Birinyi.
Still, companies that do buy back their own stock are seeing prices soar, and almost immediately.
On Friday, Northrop 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 a quarter by the end of 2015.
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, according to Birinyi.
Instead of getting excited, though, some on Wall Street are worried.
Gregory Milano, CEO of consultancy Fortuna Advisors, has run studies showing that companies buying back their own stock the most tend not to spend enough opening new factories or investing in R&D or building their business for the long term, ultimately hurting their investors. Andrew Smithers, who runs a London-based investment consultancy, thinks buybacks have pushed stocks more than 40 percent higher than they’re worth.
Another problem is that buybacks can give investors a false sense of strength of the true earnings power of a company. 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.
Even if you’re worried, it’s not clear what you should do in the face of this massive corporate buying, which shows no signs of easing. Howard Silverblatt, senior index analyst at S&P Dow Jones Indexes, notes that S&P 500 companies have plenty of cash to keep buying — a record $1 trillion, not counting money set aside in reserves as required by regulators.
The dilemma facing buyback skeptics who are thinking of selling is the same one facing those worried the rise in the market has come mostly from the Federal Reserve efforts to stimulate the economy. “Don’t fight the Fed,” the old Wall Street saw goes.
To which should perhaps be added, “Don’t buck the buybacks.”