I think few people would argue with the observation that bull market tops are often accompanied by excessive enthusiasm, euphoria, and a late rush by retail investors to own stocks. The final phase of bull markets has been characterized as the blow-off or speculative phase, as stocks rise on hopes and expectations. Those who have missed the party finally capitulate, joining in at the wrong time in hopes that the music will play on.
It we were to assume (which could be a big mistake) that this scenario of retail investors boldly moving in during the final act will play out again, it would likely indicate that we are not yet at the end of this six-year bull market. But perhaps the retail investors are not who we should be watching.
The chart below from Haver Analytics and Citi Research caught my attention, as it demonstrates a vast distinction in who is buying stocks. The short answer: corporations.
Below we can see that S&P 500 companies have been buying back their own shares at a much greater rate than money from retail investors has been flowing into domestic equity mutual funds and ETFs.
As discussed in this article, buybacks have been a major factor in driving this market higher. And considering that buyback authorizations remain on a blistering pace, this trend could be a major contributor to higher prices ahead.
Some worry about the lack of retail participation, and rightly so. We’ll explore some of those ramifications momentarily, but briefly I’d like to reiterate that corporate buybacks can be extremely beneficial for stock prices.
When corporations repurchase their own shares through buyback authorizations, they are buying large chunks of their own stock. Unlike money managers who are often buying and selling, corporate buybacks are one-way streets. They result in fewer shares outstanding (lower supply), and higher earnings per share, both of which are catalysts for higher prices.
Companies repurchasing their own shares is in many ways analogous to central banks engaged in QE; both are intervening in their own markets, buying up securities while acting as major sources of demand and constraints on supply. With so many companies set to initiate and execute buybacks during the rest of 2015, this catalyst favors higher share prices.
But caution is in the wind; recent history demonstrates that corporations can be as awful at timing the market as retail investors. In 2014, S&P 500 buybacks totaled 3.3 billion. This is just short of the record 9.1 billion set in … you guessed it, 2007 - the year the market peaked ahead of the great recession.
I should mention that companies engaged in buybacks are by no means trying to time the market; they’re attempting to deploy capital in the most shareholder friendly manner. That being said, there are some interesting implications regarding the timing of when businesses generally opt for repurchase programs.
One of the criticisms of the current economic landscape is a lack of business investment. However businesses invest heavily in growing their core operations only when the economic outlook is rosy. Management must be confident that capital put to work will be met by strong consumer demand. Buybacks thus become increasingly attractive when economic uncertainty looms.
Market tops also frequently coincide with the end of the expansionary phase of the business cycle. At this stage corporate profits have typically peaked and corporations are flush with cash. They are under pressure to utilize that cash productively or return it to shareholders, and with growth prospects becoming hazy, repurchase programs shine.
Returning to retail investors, a recent study by Bankrate shows some disturbing statistics. According to them, roughly 52% of Americans are not invested in the stock market. Of those not investing, one of the more commonly cited reasons was not understanding the market.
I think we can all relate. I watch the markets daily, write about them frequently, and they still baffle me constantly. It’s one of the reasons why my personal investing methodology has drifted away from stock picking over the years and more towards understanding broader trends in the economy, investor behavior, and prices.
When you consider that professional money managers in aggregate are unable to outperform the market, it makes you realize how few people really do understand the market.
The other part of the story behind why retail investors aren’t in the market is a lack of money. According to the same study, over half of those who were not invested simply did not have money to invest. This is a particular issue for millennials, of whom only 26% are investing in the market. I guess it’s no wonder when underemployment and student loans are constricting that age group heavily.
Along the same lines of “not having money to invest,” the National Institute on Retirement Security recently found that 45% of working-age households have zero retirement savings. The 55-64 age group had an average of 12,000 in retirement savings.
With money to invest so scarce in the retail segment, markets increasingly volatile, and scars from the financial crisis still fresh, perhaps the next market top will not be marked by irrational exuberance from retail investors. Perhaps this time the final push higher will come from corporations themselves, as economic prospects dim and they run out of value adding initiatives within their own core operations, leaving them no better alternative than to repurchase their own shares.
The preceding content was an excerpt from Richard Russell's Dow Theory Letters. To receive their daily updates and research, click here to subscribe.
Related:
Charles Biderman: Earnings Are Irrelevant - Companies Driving Market Higher With Record Buybacks
