John Hussman: Don't Get Excited by Stock Repurchases

Excerpt from fund manager John Hussman's weekly essay on the U.S. market:

In recent weeks, investors have been enthralled with the idea that stocks are being supported not only by earnings surprises, but also by heavy repurchases... Doesn't this eagerness to retire stock mean that valuations are cheap?

There are several responses. First, we observe no such eagerness to buy company stock in the insider purchase statistics -- that is, company executives buying their own stock with their own money. We continue instead to observe unusually high insider selling.

Second, a good portion of the repurchases are being made to offset the grant of shares to executives and employees. It's true that we're observing net repurchases overall, but they're well below the volume of gross repurchases.

Third, the statistical correlations between repurchases and valuations or subsequent returns are small at the individual stock level, and are even weaker for the market as a whole. There is simply no evidence to support anything close to the confident cause-effect statements regularly offered by analysts on CNBC.

Indeed, if we measure net stock issuance or retirement (including through corporate buyouts and the like), one of the better explanatory variables seems to be the spread between corporate bond yields and Treasury bond yields. The blue line in the following chart is the estimated change in the S&P 500 divisor attributable to net issuance or retirement of stock (as a percentage of shares outstanding), while the red line is the spread between the yield on the Dow Jones Corporate Bond Index and the 10-year Treasury yield...

Suffice it to say that the retirement of stock we're observing lately is far more related to credit spreads than it is to any attractiveness of valuations here. There is no evidence that such periods have had useful implications for subsequent stock returns.

Comments

[Richie:]

John,

While your investment track record is un-remarkable, in this article, I agree with your premise. The problem I have with your argument is that it is shallow. You arrive at a conclusion that has merit, but you advance only the most obvious evidence, failing to address many other glaring consequences of corporate consumption of their capital.

Increasing earnings per share without increasing earnings and without increasing revenues will inevitably lead to serious problems. And consuming cash and in some cases BORROWING funds (e.g. IBM) to buy back shares often at many multiples of book value is simply poor management.

There are many other problems that will result from today's frenzy of corporate stock buy-backs. The US stock market is depressed relative to all major commodities and currencies as well as other stock markets for good reason.

2007 May 01 01:47 PM