It is very important for investors to monitor the total amount of share repurchases in order to assess where we are in the economic cycle. When the economy is in a recession, the share buybacks are minimal because the companies prefer to preserve their cash to overcome the rough times. As the economy starts to recover from the recession, the share buybacks tend to follow up but they remain low because the companies find many profitable projects to invest in and hence they are not left with much spare cash.
However, when the economy approaches the top of its cycle, the companies cannot find many profitable projects to invest in and hence they greatly increase their buybacks in order to enhance their earnings per share and thus their share price. At this stage, they find it very difficult to increase their earnings so they try to improve their earnings per share. It is remarkable that near the top they prefer raising the buybacks to raising their dividend because a higher dividend would be a commitment that would always pursue them; when the earnings would fall later, they would have to reduce the dividend, which would be a hard and unpleasant task, as shareholders never want to hear of a dividend decrease. Therefore, the companies greatly enhance their share repurchases near the market top. The great correlation between the total amount of buybacks and the S&P (NYSEARCA:SPY) is shown here.
This year, many investors are concerned for the great number of announcements of new programs of share repurchases. To be sure, Apple (NASDAQ:AAPL) has initiated a buyback program for the first time this year and has already spent more than $20 B in it. Moreover, International Business Machines (NYSE:IBM) has reported its commitment to purchase $10 B of its stock every year for the next few years. If one adds the aggressive buyback programs announced by other companies, such as Visa (NYSE:V), Microsoft (NASDAQ:MSFT), Oracle (NASDAQ:ORCL), AT&T (NYSE:T), Deere (NYSE:DE), Pfizer (NYSE:PFE), Viacom (NASDAQ:VIAB), even Green Mountain Coffee Roasters (NASDAQ:GMCR), then one starts to worry that a market top is imminent.
Nevertheless, the amount of $123 B total buybacks in Q2-2013 is not an extreme amount. To be sure, it is somewhat less than the amount of Q3-2011 and much less than the amount of $180 B recorded at the top of the previous cycle in Q3-2007. Therefore, although the great number of announcements of new buyback programs does not send an optimistic signal for the prospects of the earnings of the companies, the total amount of buybacks is not extreme and could greatly rise before a market top is in place.
Apart from the escalating buyback programs, there are two other ominous signals for a market top nearby; the leverage in the market, which is near its record levels of 2007, and the news that the retail investors have exhibited a great positive cash flow into stocks for the first year in the 5-year bull market. Indeed, I believe that a bear market will begin a few months or weeks before the Fed starts to reduce its bond purchases. The Fed tapering has already proved that it is scary to the investor community and hence it will trigger extensive profit taking, leading the market much lower. Nevertheless, I believe that the bear market will be shorter and much less intense than the bear market of the Great Recession of 2008. As I have described in a previous article, I believe that S&P and Dow Jones (NYSEARCA:DIA) will advance to unprecedented highs in the next few years.
Disclosure: I am long IBM. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.