Buyback Blackout Periods Do Not Negatively Impact Market Performance

The October 2018 market correction where the S&P 500® Index fell by 7%, its worst October since 2008,(1) left investors searching for a culprit. Some of the usual suspects were blamed — rising geopolitical tensions ahead of the US midterms, the high likelihood of a slowdown in economic and earnings growth after the sugar rush of fiscal stimulus and tighter monetary policy leading to higher rates and investors discounting stocks’ future cash flows at that higher rate.

Non-market based theories were floated as well. ETFs were placed at the helm of a ship making a hard downward turn, but that theory didn’t pass the muster of math, as pointed out in a prior research piece.(2)Another theory held that the market’s sudden dips were caused by companies’ inability to buy back shares ahead of their earnings announcements.(3)

This is an interesting theory and one we haven’t really come across before, as the impact of buybacks on stock prices and shareholder value, both in the long and short term has been well documented. Among many other reports, “The Case for Stock Buybacks” by Edmans [2017] addresses the long term effects(4) while “The Share Repurchase Announcement Puzzle: Theory and Evidence” by Bhattacharya and Jacobsen [2016] covers the short term.(5)

As a refresher, buybacks are when a company purchases its own stock in the public market for reasons that range from managing capital allocations between debt and equity to returning cash to shareholders.(6). Some companies temporarily suspend share buyback programs during earnings blackout periods. These periods typically start a few weeks(7) prior to reporting and end a few days after the earnings release.

Under the buyback blackout theory, performance is anticipated to decline because firms cannot buy back shares before earnings releases, depressing price support as a possible persistent buyer has temporarily left the market. Given the attention this theory received in the media during the 2018 third quarter earnings season, we decided to take a closer look. Our analysis here is not meant to produce an empirical trading model or refute the economic impact of firms conducting buybacks. Nor is it to say that, during earnings season, going long firms that have been known to buy back their shares in bulk provides a source of uncompensated alpha. Rather, we offer data-driven insights to answer the pundit’s question of whether the market falls during earnings “blackout” periods.

Does the Buyback Blackout Period Theory Hold Any Water?

Buybacks have been a common target for market prognosticators theorizing why large-cap US equities have hit multiple new all-time highs in recent years. With so much attention on the way up, attention on the way down is just natural. A July 2018 headline captures the most extreme view on buybacks and market impact “Companies buying back their own shares is the only thing keeping the stock market afloat right now.”(8) Examining the historical relationship between buybacks and market returns provides useful insight into this narrative.

While Bhattacharya and Jacobsen [2016] examined the effect of buyback announcements, suggesting the announcement impact effect was between 1% and 2% on average, we are focused on the buying of shares and its broader impact. Determining the precise impact on returns is difficult given the number of variables to consider (date, size, frequency, trading strategy). Therefore, we seek to examine the relationship based on historical return patterns and the amount of shares being purchased as a percent of market cap. We find the linkage between the two to be low, indicating that the rise in equity values over the past few years has not been a direct result of an increase in buybacks — a view shared by Asness, Hazlekorn, and Richardson [2018] “Buyback Derangement Syndrome.”(9) Figures 1 and 2 represent this seemingly uncorrelated relationship.

Figure 1 depicts the S&P 500 Index closing value versus the quarterly buyback amounts by S&P 500 firms aggregated on a monthly basis from FactSet. Looking at this chart, one would most certainly conclude that there is a linear relationship between buybacks and the movement in stock prices. After all, buybacks hit an all-time high at the same time the S&P 500 did in 2018. But looking at the total notional figure of buybacks is distorted by the fact that companies over time have gotten bigger. We present this analysis to show how and why the buyback narrative can gain traction, as there appears to be a correlation.

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