TSP

Corporate tax cuts and repatriation of overseas cash has resulted in a wave of stock buybacks.

By: Lyn Alden

After a particularly rough start to the month during the first two weeks of October, American stocks mostly stabilized during the third week. However, volatility in U.S. markets remains at a six-month high, and most companies are in the process of reporting third-quarter earnings results.

While nothing is for certain, the good news is that all else being equal, corporate stock buybacks are likely to be a positive tailwind during November and December for the S&P 500 and the C Fund that tracks it.

Corporate stock buybacks are when companies buy back their own shares and reduce the number of shares in existence. This results in company-wide revenue, earnings, and dividends being divided over a smaller number of shares, meaning the per-share value of each of those metrics increases. In addition, due to heavy buying activity by the companies themselves, there is increased demand for corporate shares which can support higher stock prices during those periods of heavy buybacks.

Due to the corporate tax cuts passed last year, companies (especially the tech giants like Apple and Microsoft) are bringing hundreds of millions of dollars back to the United States, which they have been accumulating overseas for years. And for the most part, they are spending this cash repatriation on stock buybacks.

The full year of 2018 is on track to be the biggest year of share buybacks ever. We might hit $1 trillion by year’s end:

Chart Source: JP Morgan Guide to the Markets, 3Q18

However, stock buybacks don’t happen on a perfectly consistent basis like clockwork. Some months have heavier share repurchases than others.

For the last two weeks of each fiscal quarter until after quarterly earnings are announced, most companies are in a self-imposed stock buyback blackout period. This means that while they can continue with pre-planned regular stock buyback plans that were already set in place far ahead of time, they can’t decide to do additional or accelerated buybacks around earnings season.

As a result, history shows that the months where most companies report earnings tend to be the lightest months in terms of corporate stock buybacks. These are the months of January, April, July, and October.

According to a research report by Goldman Sachs a few years ago, for example, October is one of the lowest months for stock buybacks, and there’s a clear pattern of lower buybacks during months where most companies report earnings and have buyback blackout periods (darker blue):

Source: Goldman Sachs Global Investment Research, March 2015 Report

During this year of record corporate stock buybacks due to unique cash repatriation, November and December are likely to have strong tailwinds from major corporate buyback activity. In contrast, we probably had lighter buyback activity in October, which makes it easier for market sell-offs to occur.

That doesn’t mean stock prices can’t go down in November and December. A major crisis or any random event could result in sharp stock sell-offs.

However, a resumption of record-breaking buyback activity after this blackout period ends later this month is one strong variable that can help support stock prices in the C Fund for the last two months of the year, all else being equal.

Smaller stocks in the S Fund are less affected by this pattern, because most of them aren’t doing major cash repatriation, and for the most part they spend less money on buybacks than the large companies in the C Fund.

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Lyn Alden is a financial writer and an engineer, and holds a bachelor’s in engineering and a master’s in engineering management, with a focus on financial modeling and resource management. She specializes in analyzing and presenting financial data. Her investment work can be found on LynAlden.com.