A March 23rd report from Goldman Sachs Portfolio Research argues that with equity markets currently flirting with record highs and the first quarter buyback blackout period approaching, markets are likely to come under pressure.
Amanda Schneider and colleagues offer a brief explanation of their current strategy: “The majority of companies just entered the buyback blackout period leading into the 1Q earnings season, and high valuations in the absence of corporate demand may weigh on stock prices. Investors should view any market pressure as a buying opportunity.”
Stock buybacks are currently major support for equity prices
U.S. equity markets have been climbing for several quarters on the back of stock buybacks as they represent a major source of demand for equity. The GS analysts project that S&P 500 firms will up stock repurchases by 18% to $604 billion by the end of the year. Given that close to 70% of share repurchases are undertaken using 10b5-1 programs, most firms refrain from discretionary buybacks during blackout periods that extend from roughly five weeks prior to earnings reports to a day or two after the announcement. They note: “As volumes decline, market performance appears more vulnerable to the seasonality of buyback activity.”
The GS report highlights that the vulnerability to the buybacks window closure varies by sector. Of note, Information Technology, Consumer Discretionary and Financials accounted for over 50% of total buybacks during the last four quarters. Keep in mind that financial companies typically report earlier in the season and can therefore begin repurchasing earlier. Consumer Discretionary firms, on the other hand, usually report towards the end of earnings season and therefore leave the buyback blackout window later.
Consider GS S&P 500 total cash return basket
Schneider et al. suggest an ideal strategy for the current environment is to “buy Total Cash Return stocks prior to period of seasonal strength as earnings season months coincide with weakness in the performance of our Total Cash Return basket versus the S&P 500.”
They argue that the closing of the buyback window could well result in a lower entry point for investors, and also note that historically GSTHCASH is more likely to outperform market indices in the 30 days after earnings season ends. The GS analysts note: “We believe stocks with high total cash returns will outperform as S&P 500 firms grow buybacks and dividends. These stocks offer more than twice the total cash yield of the median S&P 500 stock at a 13% P/E multiple discount.”