Slowing Stock Buybacks One of a Few Reasons to Fear Q3 Earnings

Less than a week after it was trumpeting a bullish call that would have seen stocks collectively gain 7% between then and the end of the year, Goldman Sachs hedged its bet by saying the upcoming earnings season could be a particularly bad one for the market.

Slowing Stock Buybacks One of a Few Reasons to Fear Q3 Earnings

Source: ©iStock.com/gunnar3000

Namely, between a slowdown in the number of stock buybacks and still-weak oil prices — in addition to an abnormally strong U.S. dollar — that we’ve seen over the course of calendar Q3, Goldman Sachs recommends investors stick to high-quality names that don’t rely on overseas sales.

A rough third-quarter earnings season doesn’t necessarily preclude the S&P 500 reaching 2,100 before the end of 2015, as Goldman’s chief U.S. equity strategist David Kostin predicted would happen back on Sept. 21. It’s entirely possible stocks could take an earnings-driven hit and then bounce back at the eleventh hour.

On the other hand, with 2,100 a full 11% away from where the S&P 500 is now (thanks to a sizeable pullback since Kostin’s call) on top of the earnings headwind Goldman now predicts thanks to withering stock buybacks, his optimism is less and less plausible.

Stock Buybacks Drying Up

The data won’t exist until after Q3’s numbers are reported, but based on what we know about the second quarter’s stock buyback activity — or lack thereof — earnings aren’t in any position to get the same kind of help they’ve had lately on that front.

During Q2, stock buybacks among S&P 500 constituents fell 8.7% from Q1’s levels. All told, the nation’s largest corporations only spent $131.6 billion on repurchasing shares during Q2.

The bulls will be quick to argue that Q2’s total buybacks were still considerably greater than Q2-2014’s total share-repurchase spending, which only reached $116.2 billion. The bulls will also point out that the S&P 500’s companies are on pace to authorize $897 billion worth of stock buybacks this year … which would be a record, eclipsing 2007’s mark of $863 billion.

“Authorized” isn’t the same as “completed,” but it still points to the strength of the trend.

And yet, one can’t help but wonder if we’ve seen buybacks — companies’ capacity for them as well as investors taste for them — already peak.

In a Barron’s article, Professor of economics and Director of the Center for Industrial Competitiveness at University of Massachusetts Lowell William Lazonick recently opined, “‘Where there is a lot of buyback activity, there is usually a hedge fund’ pressuring executives.” And, realistically speaking, he’s right. It has finally become a bad enough problem that even the addicts are feeling more pain than pleasure; pushy hedge fund managers are now backing off.

Indeed, even the above-mentioned Goldman Sachs penned a letter to all United States companies urging them to use their cash for acquisitions and growth rather than stock buybacks while their equities were at uber-frothy valuations.

If they listened (and it seems they may have), the third quarter could be the first quarter in a long time stocks haven’t gotten a measurable buyback boost, with stock-buyback-mania having run its course.

Not Just a Stock Buyback (Or Lack Thereof) Problem

Of course, waning buybacks aren’t the only headwind U.S. companies are facing.

The number one impasse for second-quarter earnings: An overvalued U.S. dollar.

Slowing Stock Buybacks One of a Few Reasons to Fear Q3 Earnings
Click to Enlarge
The U.S. Dollar Index was soaring in the fourth quarter of 2014, but didn’t even begin to slow down until late March.

While the dollar spent most of calendar Q3 at levels lower than Q2’s average, the greenback remained at irritatingly high levels that could create similar problems during the upcoming earnings season.

Bottom Line

With those headwinds in place, current expectations for a 3% decline in year-over-year earnings results make sense. On the flipside, it’s not exactly a secret that super-cheap oil prices have made the energy sector the scourge of the S&P 500. What would the picture look like with oil and gas stocks’ Q3 results not factored in?

Per the most recent outlook from Standard & Poor’s, not factoring in the energy sector’s projections, the S&P 500 should see earnings growth of around 6% for Q3. If it does, though, it would be doing something much different than it did in Q2.

How so? In the second quarter of 2015, the S&P 500’s per-share income rolled in about 10% less thanks to oil’s meltdown, but even taking energy stocks out of the equation, year-over-year earnings growth was mostly flat.

The question is, what flipped the earnings switch to “on” during Q3 that didn’t wasn’t available during Q2?

Answer: Nothing.

All of a sudden, the advice from Goldman Sachs sounds pretty good.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

More From InvestorPlace


Article printed from InvestorPlace Media, https://investorplace.com/2015/09/slowing-stock-buybacks-one-reasons-fear-q3-earnings/.

©2021 InvestorPlace Media, LLC