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A Slowdown In Stock Buybacks? Don’t Expect Institutional Buyers To Pick Up The Slack

According to FactSet, S&P 500 earnings will drop roughly 8.3% in the first quarter. That’ll mark the fourth consecutive quarter of declines in corporate profits-per-share. Why might that matter? There are only two occasions over the previous two decades where earnings contractions lasted longer. In both instances, the U.S. economy experienced a recession; in both instances, the S&P 500 lost HALF of its value. Does the current earnings malaise mean that history will repeat itself? No. On the other hand, there are always reasons for a slump in profits. Those who ignored the tech sector’s warnings in 2000 witnessed their portfolios disintegrate. Similarly, those who pushed aside the financial sector’s admonitions in 2008 experienced life-altering losses. There is another reason why the contraction in corporate profits are a troublesome omen. Historically, declining earnings weigh on corporate confidence with respect to buying back shares. Extended periods of earnings contractions have led companies to sharply reduce their acquisition of shares in the past. The average pace of share reduction was a peak-to-valley slowdown of 62 percent. It follows that with corporations serving as the only significant buyer of stock at this moment – with retail investors, institutional investors , hedge funds, pensions as well as mutual fund managers participating as “net sellers” – we may be staring at the peak in the corporate buyback cycle. The bullish counter-argument to the notion that companies may slash their buyback activity is the new corporate bond buying program by the European Central Bank (ECB). Specifically, the ECB’s willingness to buy non-sovereign debt – their eagerness to purchase company obligations in addition to country obligations – has the effect of tightening corporate credit spreads. In English, please? The cost of corporate borrowing around the world should move even lower. And if it does so, why… how can companies resist the urge to borrow more money to buy back more shares? There may be some validity in the thought process. After all, look at the remarkable spike in the Vanguard Long-Term Corporate Bond ETF (NASDAQ: VCLT ) in the weeks leading up to the anticipated “bold-n-creative stimulus” by the ECB. It is almost as if buyers began anticipating dramatically lower yields (higher prices) for investment grade corporate bonds. (I know that I added to long-term corporates in the week leading up to the ECB’s March decision.) Unfortunately, however, the notion that ultra-low borrowing costs alone can provide everlasting support to a bull market is false. As I pointed out in earlier interest rate commentary , there were significant bear markets – stock bears in 1937-1938 (-49.1%), 1938-1939 (-23.3%), 1939-1942 (-40.4%), or 1946-1947 (-23.2%) – when the 10-year yield was low like it is today. In all four instances, the stock market was a remarkable bargain by comparison, trading at HALF the valuation levels of 2016. In two instances – 1939-1942 (-40.4%) and in 1946-1947 (-23.2%) – rates were low and the U.S. economy was booming. Regardless of whether you wish to examine recent history, where decelerating stock buybacks peaked and sharply reversed course alongside contraction in corporate earnings, or whether you look for clues in the twenty year period of ultra-low borrowing costs (i.e., 1936-1955), where stock valuations were HALF what they are in March of 2016, history does not paint a pretty picture for stocks going forward. What about improvements in the technical picture? Hasn’t my favorite gauge of market breadth – the New York Stock Exchange A/D Line – demonstrated that the stock bull is back? Not really. Not yet, anyway. At the moment, the A/D Line is bumping up against the same resistance as it did in the October-November period. The February-March bounce has more of the markings of a bear market rally than a true blue bull. Moreover, the downward slope of the A/D Line’s long-term trendline is more indicative of future volatility and bearish implications. The same technical analysis uncertainty exists in popular ETFs like the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). The downward slope of the 200-day moving average is bearish. What’s more, the October-November bounce logged “lower highs.” The same appears quite probable for the current rally. Additionally, there are plenty of technical signs that are rather disadvantageous for risk assets . For instance, one is only going to find 40% of individual stocks above respective 200-day moving averages. Similarly, in the immediate-term, Bespoke Research reports that two-thirds of S&P 500 stocks are overbought. In sum, earnings are awful and fundamental overvaluation remains irksome. Also, corporate buybacks are slowing at a time when corporations are the primary support for low volume price appreciation. Most historical comparisons to similar circumstances are unfavorable. And the technical forecast is “cloudy with a chance of afternoon thunderstorms.” If only the headwinds stopped there. Political uncertainty is also hampering risk-taking in equitites . Does anyone truly believe that Trump and Sanders would be influential in the present primaries if the U.S. economy were “hunky-dory?” Voters do not vote to bring down the establishment unless they are disturbed by threats to their financial well-being. Consider these realities: (1) Since the Great Recession ended, the percentage of Americans who own homes has FALLEN from 67.3% to 63.8%, (2) Since the Great Recession ended, real median household income has FALLEN from $54,925 to $53,657, and (3) Since the Great Recession ended, millions of 25-54 year old Americans are no longer working, as the percentage of people in the 25-54 demographic working has FALLEN from 83.5% to 81%. In what prior economic recovery have wages decreased, the rate of home ownership decreased, and the percentage of working-aged individuals in the labor force decreased? None. In other words, economic weakness breeds political unrest; both are significant headwinds to stock price gains. Perhaps the most disconcerting misrepresentation in the media is the headline unemployment rate of 4.9%. In reality, job creation in low-wage industries has not been able to keep up with the growth of the working-aged population. The Federal Reserve’s own Labor Market Conditions Index (LMCI) reflects the reality that the misleading employment data fails to capture the weakness in actual employment trends. It should be noted, in fact, that the LMCI is currently contracting. It follows that if the Fed pays attention to its own LMCI, as opposed to the Bureau of Labor Statistics ( BLS ) headline U-3 data point of 4.9%, they may back off the rate hike train. My guess? They’re going to maintain their guidance of gradual stimulus removal. So they may not hike overnight lending rates in March. Yet they may do it in May or June. And that would likely come at a time when corporate profits will be set to decline for a fifth consecutive quarter. Put on your safety goggles! Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

U.S. Diversified Equity Funds Are Still Feeling The Effects Of 2008

By Patrick Keon Click to enlarge Funds in Thomson Reuters Lipper’s U.S. Diversified Equity (USDE) Funds classifications have experienced negative net flows of $10.9 billion for 2016 year to date. These results are the continuation of a long-term trend that has seen USDE Funds’ coffers shrink on an annual basis every year except one since the global financial crisis of 2008. USDE Funds managed to record a slim net inflow of $9.3 billion for 2013 to break up the string of negative results. Overall, the USDE Funds group has had net outflows of roughly $661 billion since 2008. Looking at the individual USDE fund classifications, we see that each has had overall net outflows since the crisis except for one, Multi-Cap Core (MLCE) Funds. MLCE Funds took in $106.4 billion of net new money during the period. The group suffered net outflows for only one year (-$73 million for 2010) and was most productive during 2013 and 2014, when it took in a combined $60.3 billion net. The USDE classification with the largest net outflows was Large-Cap Core (LCCE) Funds. LCCE Funds experienced over $288 billion of negative net flows during the period, which was over twice the amount of the classification with the second largest net outflows (Large-Cap Growth Funds, -$134.1 billion). LCCE funds suffered outflows every year in the tracking period, with the two largest outflows coming in back-to-back years (2011 and 2012) during which time $140 billion left its coffers. The results for 2016 are playing out the same as above: MLCE Funds (+11.0 billion) has the largest net inflows among USDE funds, while LCCE Funds has posted the largest net outflows (-$7.4 billion). Within the MLCE space Vanguard Total Stock Market Index Fund (MUTF: VITSX ) (+12.0 billion) has had the largest net inflows for the year to date, while for LCCE Oakmark Fund (OAKMK) (-$1.1 billion) and MainStay ICAP Select Equity Fund (MUTF: ICSLX ) (-$637 million) have posted the largest net outflows.

In A Big Retail Sector, This Group Is Worth Watching

Retailer Urban Outfitters ( URBN ) soared Tuesday after earnings topped expectations. But one day of strong price performance doesn’t make a stock an industry group leader. It takes a lot more than that. Urban Outfitters is a member of IBD’s apparel retail industry group. The group has rallied about 21% since its mid-November low. Over the same time, the S&P 500 is down about 3%. Leadership is fairly broad in the group. As of Monday’s close, four names owned Composite Ratings of 90 or higher, and should be regarded as the group’s leaders. Discount retailer Ross Stores ( ROST ) hasn’t made a lot of progress after a breakout over a 55.74 buy point, but it’s still holding near highs on the heels of a strong earnings report March 1 that saw the company deliver its seventh straight quarter of double-digit profit growth. As part of its earnings release, the company also upped its dividend 15% to 13.5 cents a share. The dividend is payable March 31 to shareholders of record March 14. Competitor TJX Companies ( TJX ), which operates TJ Maxx and HomeGoods stores, is more than twice the size of Ross Stores, with a market capitalization of just over $50 billion. When it reported Q4 results last month, TJX announced plans to raise its quarterly dividend by 24% to 26 cents a share. It also plans to buy back $1.5 billion to $2 billion of stock in the current fiscal year that ends next January. TJX is also showing relative strength. It’s trading tightly and is still in buy range from a 74.75 entry. Small cap Express ( EXPR ) is showing some signs of accumulation as it works on the right side of a base with a 20.82 entry. Q4 earnings are due Wednesday before the open. Earnings are expected to rise 33% from a year ago to 65 cents a share. In January, Express raised its Q4 guidance thanks to strong holiday sales. Express is a specialty apparel and accessories retailer of women’s and men’s merchandise, targeting the 20- to 30-year-old crowd. Another small-cap, Francesca’s ( FRAN ), is holding near highs, but is extended after a breakout in December over a 15.60 cup-with-handle buy point. It’s been getting support at its 10-week moving ever since the company raised its earnings guidance in January, also due to strong holiday sales. Francesca’s hasn’t announced an earnings date yet, but it should be later this month. After several quarters in a row of declining earnings growth, quarterly profit is seen rising 62% to 34 cents a share with sales up 23% to $132 million. Last month, the Commerce Department released solid retail sales data for January. Recession fears were quelled by news that overall sales rose 0.2%, in line with expectations. December sales were revised upward to a 0.2% gain from a previously reported decline of 0.1%. Core retail sales jumped 0.6% after falling 0.3% in December. February retail sales data are due Tuesday next week.