This post was originally published on this site
A trader takes an order in the Standard & Poor’s 500 stock index options pit at the Chicago Board Options Exchange following the Federal Open Market Committee meeting on January 25, 2012 in Chicago, Illinois.
Scott Olson | Getty Images News | Getty Images
Corporations have been the biggest buyers of stock during the bull market. But they’re slowing down, which could be a troubling indicator.
Typically, the public is considered the “crowd” in stock markets, or put another way, “dumb money.” Retail investors tend to buy the most at the top and sells the least at the bottom. Retail investors have not been participating as much in the market, making it harder to use that crowd as an indicator of sentiment. But Ned Davis, senior investment strategist at Ned Davis Research, said there appears to be a new crowd to watch: companies.
“Strong public selling should be bullish but perhaps the crowd this cycle is corporations,” Davis wrote in a note to clients Wednesday. “The non-financial corporate crowd has piled into stocks with buybacks, mergers, and acquisitions.”
Davis pointed out that recently, new corporate offerings have jumped to the highest level in years. This includes big initial public offerings like Uber and Lyft, as well as secondary offerings from companies such as Tesla. Based on that, “maybe even the corporate crowd is starting to feel stocks are overdone,” Davis said.
Investors believe it’s a basic supply and demand equation. Demand for stock in the form of buybacks is declining, while supply of shares through IPOs and other issuance is increasing. When supply outstrips demand for a product, typically the price falls and stocks are no different, they argue.
That surge in buybacks is showing signs of weakness though — an indicator that companies are less optimistic about the future. According to Larry McDonald, editor of The Bear Traps Report, a sharp slowdown in capital expenditures means companies are also going to buy fewer of their own shares. The latest quarterly capital expenditures for the S&P 500 came in at the lowest since the fourth quarter of 2017, which is “foreshadowing” of a decline in stock buybacks.
“In our view, the prolonged trade-war (and the uncertainty it brings) has paralyzed CFOs and their ability to invest for the future,” he said.
McDonald pointed to business confidence, earnings, and exports “all rolling over significantly.” Buybacks are often fueled by corporate debt. In order to buy back their own stock, companies borrow money as a funding strategy. According to McDonald, more than 50% of the debt issuance in the past decade has been used to buy back stocks.
“We’ve started to see cracks in terms of debt issuance. This pierces company’s buyback ability,” McDonald said.
Instead of high-yielding, but riskier corporate debt or junk bonds, investors are fleeing to safer options like U.S. Treasurys. Trade war jitters sent the 10-year Treasury note yield, which moves in the opposite direction of prices, to its lowest level since September 2017 Wednesday. That triggered concerns about the economic outlook, sending stocks down as much as 400 points. Increasing trade tensions in the China-U.S. trade fight also weighed on markets.
“I’m confident that capital markets are going to shut down meaningfully for an extended period,” McDonald said.
