Is The Bear Market Coming? Buybacks In The U.S. Are Massively Falling

Companies listed on the stock exchange may reward their shareholders in two main ways: by buying back their shares or by paying dividends. Let us remind you of the meaning of the former.

Share repurchase or buyback is a transaction whereby a company buys back its own shares from the stock market. After repurchase, the shares are canceled or held as treasury shares, so they are no longer held publicly and are not outstanding. Because a share repurchase reduces the number of shares in circulation, it inflates prices of the existing shares trading on the market.

Also, companies buying back their shares create additional demand on the market. Let's assume that on the regular market we demand 200 000 shares, if the company buys additional 200 000 shares then we automatically have large advantage of buyers over sellers which eventually increase share prices even more. Of course, when we have less stocks in circulation then existing shareholders increase their shares in the company.

Over the last two-quarters companies has decreased their amount of share repurchases. In the second quarter of 2019 U.S. companies spent 166 billion USD on buybacks. In the first quarter, it was 205 billion USD and 223 billion USD in the last quarter of 2018. Previously, when the amount of buybacks started to decrease from quarter to quarter, the S&P 500 index fell into a bear market, which is shown on the chart below (years 2000-2001 and 2007-2009).

This time, the relation between buybacks and the S&P 500 has not been that clearly seen yet, but when we get into details then we can see that small companies are already showing significant weakness.

source: stockcharts.com

Russell 2000 Index (blue line), consisting of small-capitalization companies has lost more than 12% in one year. On the other hand, the S&P 500 Index (green line), has barely changed. There is a reason for that - small companies has not been supported by buybacks as it was the case of large companies in the S&P 500 index. Currently, when share repurchases are also falling for the S&P we have a much greater risk of share prices declines than in the last few years.

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