Buyback Magic (DIA,QQQ)

Buyback Magic (DIA,QQQ)

Buyback Magic (DIA,QQQ)


There are two distinct and opposite forces currently operative in the domestic equity market, both of which have significant clout.


The first is bullish, and, as our partner in crime, Hugh L. O’Haynew, outlined earlier in the week, it’s accounted for exclusively by the corporate buyback tsunami that began shortly after Sir Trumpendonald’s tax relief regime was passed into law late last year.


The size and scope of those buybacks has been ginormous, and we’ll have more to say on the matter in a moment.


The second active force in the market is bearish and is accounted for by everyone else who plays the investment game, including fund managers, institutional investors and regular hacks like you and me.


The reasons for their selling are manifold and include, among others, weakness in emerging markets, European politics and debt, trade wars, rising interest rates and a general sense that stocks have just gotten too pricey over the last year and a half.


Indeed, a 39% rise for the Dow and a 56% percent climb on the NASDAQ since the Trumpendonald won the election is something that should get everyone squinting.   We’ll have more to say about that performance discrepancy further on, as well.

Rest assured that over the longer term we still believe the bulls hold the better hand, but at the moment we’re having our doubts.


For several reasons.


Itchy Eyebrows


As for the buybacks, they’re getting larger by the day – or so it seems.  As of the halfway mark of 2018, a full $642 billion in profits have been shoveled back into the stock market to retire shares.  And that’s a sum already larger than any full year’s worth of buybacks, ever.


At the beginning of the year, most analysts estimated that some $850 billion worth of stock would be repurchased, but as the months passed, additional announcements have put us on track to best a trillion dollars easy by year’s end.


It’s a worrisome development in many respects, as corporations are notoriously bad market timers.  It would therefore fit the contrarian script for them to be handing over their companies’ profits at the height of the economic cycle after one of the best-ever two year periods in market history.


Moreover, the numbers show that the greater part of that cash is not having the desired effect.  FactSet reports that 57% of companies buying back stock saw their shares underperform the S&P 500 year-to-date.


So what’s the point?  If you’re not getting any bang for your buck, what to do next?

Opposite the corporate stock-buying apparatus stands just about everyone else.  And they’re not happy with what they see.


Institutional investors are especially downbeat regarding what’s next for markets.  In the latest Global Macro Survey conducted by Barclay’s, better than half the 400 respondents from around the world reported expecting a ‘downside surprise’ sometime in the next year.  That high a number hasn’t been registered in at least four years.

Morgan Stanley, too, penned a letter to individual investors citing trade wars and a potential Italian Bond breakdown as reasons for investors to begin taking profits – particularly in tech stocks, whose time has come, they said, to breathe the chloroform.


Indeed, just a handful of tech stocks have been responsible for the gains across the market this year, and – surprise, surprise – it’s those same giants that have been spending their cash on Tequila and share repurchases.


Have a look –

It’s hard to fathom a market so concentrated, where just a handful of names can lift the indexes while the overall tide is receding.


But that’s exactly the case.  And we find it noteworthy that Apple Inc. (highlighted above, in red), whose sales are expected to grow in 2019 by the smallest percentage of all those companies listed (just 4% against an average of 17.5% for the rest of the group!), was also the key contributor to the overall buyback numbers.  On May 1st of this year, the company announced its intention to repurchase an unbelievable $100 billion in stock, a number that exceeds the combined announcements of the next ten biggest declarations year-to date.


It’s mind boggling, and it bespeaks a certain desperation, we believe, that a company of this sort would resort to such drastic action to bolster its stock price.


It also wears at the confidence that Apple remains a ‘growth’ story at all.


How to Trade the Bugger!?


We’re going to recommend a one-way down ticket today using the difference between the Dow’s and NASDAQ’s respective performances over the last six months.


Again, we view the NASDAQ’s numbers as largely generated by enthusiasm for large tech and the buybacks that have supported them until now.


Opposed to them, we see the Dow’s performance as more representative of the ‘real’ market, where a greater measure of skepticism – and even downright bearishness – has ruled the day.


Have a look here –

Since market lows were registered in the second week of February, the Dow and NASDAQ have taken completely separate roads.  While the Dow has gone sideways to nowhere with a half percent loss, the NASDAQ has since climbed better than ten percent (blue squares).


Our sense is that the entire market is growing skeptical of the latter’s gains, and, in light of the manifold headwinds now bearing on equities, we’ll shortly see a retrenchment in the techies that better aligns their performance with that of the Dow.


We’re playing it over the short term with the above-charted ETF’s, the Invesco QQQ Trust Series (NASDAQ:QQQ) and the SPDR Dow Jones Industrial ETF (NYSE:DIA).


And it goes like this…

- Content protected for Normandy Executive Lounge, Option Trader Elite, Executive Lounge members only]

We wouldn’t expect this to take too long to unwind.  And if we’re wrong, and the market heads higher, your losses will be limited to a pretty penny.


Many happy returns,


Matt McAbby

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