Who’s buying equities these days? If trade volumes are any indication, not many folks—at least according to headlines.[i] Which means, by Fleet Street logic, if stock buybacks are surging, corporations must be the only buyers—and without them, the bull would be in trouble, lacking buying power to drive stocks forward. But this theory ignores some key things, like how markets work—and how buybacks really influence them. Stock buybacks are groovy, but they aren’t the only thing driving this bull market.
Buybacks have been hot for this entire bull market, but 2014 has been especially gangbusters. US corporations bought back $338.3 billion of stock in the first half of 2014, the most of any six-month period since 2007. The number of companies with a repurchase program is the highest since 2008. At the same time, trading volumes are low, so headlines put two and two together (they think) and say if buybacks stop, the bull’s out of gas because regular folks just aren’t buying.
This is sheer fallacy. Corporations aren’t the only buyers. They may get the most headlines, but with 329 and 164 billion shares changing hands on the NASDAQ and NYSE, respectively, year to date,[ii] it’s clear many, many others are trading too. The $338 billion in buybacks is a teensy share of the $6.5 trillion[iii] worth of shares that have traded hands in the NYSE this year alone—to say nothing of the many, many more that traded in the dozens of other trading venues in the US. Yes, volume has decreased in recent months—August had the smallest share volume in both the NASDAQ and NYSE for the year[iv]—but markets don’t need lots of activity to generate big moves.
The stock market is an auction marketplace—the number of buyers isn’t critical to price movement. A bidding war needs only two players—stocks can move big even if just a couple of buyers bid prices way up and nobody else trades. NYSE trading volume was light in 2009, and most of the second half was below the already-low full-year average—but the S&P 500 Price Index rose 21.3% from 6/30 through 12/31.[v] The lowest-volume months—July, November and December—saw the S&P rise 7.4%, 5.7% and 1.8%, respectively.[vi] While NYSE’s measure is only a snapshot of volume given how fragmented trading has become, it shows you don’t need big trade volume for big movement.
Stock buybacks are one of this bull market’s drivers, but in a different way than recent headlines suggest. They imply the transaction moves the market. Reality isn’t so myopic—the benefits are much broader. When corporations buy back stock, it gives their earnings-per-share a boost (reducing the denominator, share count), raising the value for shareholders. Reducing supply also (all else equal) tends to boost share prices, making buybacks a way for companies to return cash to shareholders (an alternative to dividends with more favorable tax treatment in some situations).
Buybacks also reduce the number of shares available in the broad market, keeping the overall supply of equities in check. Limited supply, coupled with strong and rising demand, generally means higher prices, and buybacks are far from the only source of demand. The global expansion continues, and leading economic indicators suggest many countries are gathering steam—that bodes well for earnings looking ahead. The most competitive developed economies also have gridlocked governments—markets are happiest when big laws altering property rights and the distribution of capital and resources can’t pass. Plus, sentiment still remains on the fence, with many investors just starting to become optimistic about stocks—a sign demand has a ways to grow.
Buybacks are a fundamentally bullish feature, one way companies attempt to drive up shareholder value. But even if they slow down a bit, there are plenty other reasons for the bull to charge ahead.
[i] Thing is, trade volumes don’t really measure how many buyers you have. They measure the number of shares buyers and sellers agreed to trade on a particular exchange. The number of trades won’t even tell you how many actual buyers or sellers you have, as large blocks of stock are occasionally split into multiple executions on an exchange. Hence, “volume” is really just a murky metric. Despite what some suggest, there is no way to interpret this statistic as providing some notion of the markets’ je ne sais quoi.
[iv] Share volume in August was 33.5 billion for the NASDAQ and 850 million for the NYSE. The average for January-July was 42.3 billion for the NASDAQ and about 1 billion for the NYSE.
[v] FactSet, as of 9/17/2014. S&P 500 Price Index, 6/30/2009-12/31/2012.