The 'Great Shrinkage' Has Been A Much Bigger Stock Market Story Than The 'Great Rotation'

seinfeld shrinkage george costanza jason alexander‘I was in the pool!’

Companies have been buying back stock like crazy lately.

Some are even taking advantage of cheap credit to finance  buybacks with borrowed money.

Of course, many investors would rather see extra cash reinvested for growth.

But with limited opportunities in this slow growth environment and low returns on cash in this low interest rate environment, buybacks have been one of the favoured methods for returning wealth to shareholders.

With so many companies announcing they would engage in this practice, Deutsche Bank’s David Bianco thinks the downside risk to owning stocks in the near-term could be limited.

“Robust 1Q buybacks and large authorization reloads suggest 2013 weighted average shares decline 1.5-2%,” wrote Bianco in a June 9 note to clients. “However, buybacks should be sensitive to share prices. Repurchases at high prices can destroy value. We expect buybacks to limit the downside of any summer dips, but if they lead the market higher it will raise autumn risk.”

Here’s more colour on buybacks from Bianco:

Shares shrink less than net dollars spent on buybacks of market cap because companies buy shares at higher prices than issued via employee stock option programs and rising stock prices put past option grants further into the money.

Buybacks have clearly been the dominant source of inflows into the equity market this year and last. We have always viewed the prospects of a great shrinkage more promising than a great rotation. There is little evidence of monthly QE sums directly leading to equity buying albeit depressed interest rates have helped dividend paying stocks attract income starved investors. Provided long-term interest rates don’t rise too much there should be a healthy bid for equities from both corporate and ordinary investors.

Indeed, the “great rotation” – the idea that investors would dump bonds for stocks – may go down as one of the more overrated and misunderstood ideas in the market.

Here’s a chart of buyback announcements and actual buybacks by S&P 500 companies:

stock buybacks

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