The longer this market moves higher, the more questions there seem to be about why. ”What is causing the market to move up?” Is it corporate earnings, interest rates, The Federal Reserve, companies buying back their own stock, or something else? Admittedly, we spend little time trying to pinpoint what is causing demand (buying) or supply (selling) because it changes over time, and ultimately it is not necessary for an investor to understand the reason for the trend in order to participate. In the words of Tom Dorsey:
While many of the concepts I learned in Economics 101 have been improved on over the years, one remains unchanged—supply and demand. It is the driving force behind all price changes. If there are more buyers than sellers willing to sell, then the price will rise. If there are more sellers than buyers willing to buy, then the price will decline. This is as true for the price of tomatoes as it is for the price of stocks.
That said, here is some interesting information about one very strong source of demand today. From MarketWatch:
From arlines to 21st Century Fox Inc., U.S. companies keep buying back their own shares.
Buyback announcements jumped to a three-month high in July after faltering for a couple of months, and 2014 is on track to become the third-biggest year for buybacks ever, according to Minyi Chen, portfolio manager for the AdvisorShares TrimTabs Float Shrink ETF which picks stocks in part on their buyback trends.
He sees three big reasons for the boom in buybacks, and argues that companies shouldn’t be criticized so much for repurchasing shares in bull markets. Here are the three reasons:
1. Financial engineering: By repurchasing shares, companies can maintain or boost their earnings per share, even when their actual earnings aren’t so hot. The buyback shrinks the denominator — shares outstanding. “You can call it a little bit of financial engineering,” Chen told MarketWatch, but he said he sees the logic behind it for a company that wants to bolster its per-share earnings and sustain its stock’s momentum.
2. A better way to return money to shareholders: Companies are often criticized for buying back shares instead of investing in equipment or hiring, but Chen suggests that makes about as much sense as blasting dividend payments. He said a buyback is just another way of distributing corporate profit to shareholders, and it could be seen as a better (and increasingly popular) way of doing so because it avoids the double-taxation issue seen with cash dividends.
3. Offsetting employees who cash in: “A lot of people are criticizing the public companies for being poor market timers,” Chen said, referring to buybacks ramping up after stocks have climbed. But these critics don’t understand that “companies need to buy high,” he said, as they try to offset employees cashing in. When stock prices advance, more employees have in-the-money stock options and exercise them, while when stocks drop, employees hold back from exercising their options because they’re out of the money, the TrimTabs portfolio manager said.
Just how significant have corporate repurchases been? According the the WSJ:
Companies purchasing their own shares represent the single biggest category of stock buyers today, according to a study this month by Jeffrey Kleintop, chief market strategist at brokerage firm LPL Financial.
Maybe, retail investors will come back to the equity markets en masse in the years ahead. Maybe, corporations will continue to buy back shares. Again, as trend followers it is most important to follow the trends, even without a full knowledge of the underlying sources of supply and demand. The beauty of a point & figure chart is its ability to clearly reflect the broad trends in the market and that trend continues to be positive, as shown below in the chart of the S&P 500.
As of 8/27/14
This example is presented for illustrative purposes only and does not represent a past recommendation. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.