Company buybacks have been one of the main drivers of the equity rally this cycle. We are in the midst of the third-quarter earnings reporting period. Companies tend to enter their "blackout period" (period of time when they cannot buy back their stock so as to not "distort" their share price) 30 days before their earnings report. To date, 48% of S&P 500 companies have reported earnings, 54% having beaten consensus estimates by more than one standard deviation. However, stocks that missed consensus expectations were punished, and stocks that beat were not rewarded at all. Tough love out there.
A more interesting point is that 48% of S&P 500 companies will now exit their blackout period -- and those with large buyback programs will ramp up their purchases in the days to come. According to Deutsche Bank's calculations, this week companies with $50 billion of quarterly buybacks were off their blackout periods, and the number jumps to $110 billion by the end of next week and to $145 billion the following week. So, in the absence of additional negative news flow or further liquidations, could some support return to the market?
According to Goldman Sachs' note by David Kosten, equities reflect a sharp adjustment lower in growth expectations, with current prices equating to a near-term drop in ISM to roughly 52 -- or deceleration of U.S. economic growth of 1-2 percentage points. A similar conclusion is reached looking at the share price of 3M (MMM) , which is usually a good indicator of economic growth, and is predicting a sharp slowdown in ISM Manufacturing based on its correlation to the cycle. Even the GS Financial Conditions Index has seen a very unusual sharp tightening, nearly equivalent to an additional 25 bps rate hike. Looking at all the broader economic numbers, it seems this selling is more than overdone relative to actual fundamentals.
The U.S. GDP report released last week was better than expected -- coming in at 3.5% vs estimates of 3.3%. Consumer spending in the third quarter was strong as well, but business investment had slowed. The U.S. core CPI price index was contained at 1.6% vs 1.8% expected. So the economy is chugging along rather well and inflation is not an issue. Of course, the concern is "expected" further tightening of financial conditions post U.S./China trade wars and potential yuan devaluation impacting global trade.
The elephant in the room (or rather the dragon) remains the yuan and whether it manages to stay below 7 yuan to the dollar. We are very close to that level. Any break can have disastrous knee-jerk reactions in the equity market (lower).
U.S. mid-term elections are also nearing. If Democrats gain the majority of the house, there is a chance that a lot of Trump's policies will be undone, perhaps reversing some of the market gains. President Xi Jinping is waiting on the sidelines to see the outcome of this result before coming back to the table, if at all.
October tends to be tax year-end for mutual funds and year-end for some hedge funds. Judging by the performance of these funds this year, there could be a nasty month-end close, as fund managers close losing stocks this year and chase the winners. A marked-to-market trade -- something to bear in mind.
All in all, investors might need to wait till after the U.S. mid-term elections to see the real move in the equity market. The yuan and USD are key to the performance of commodities and China-exposed stocks.
We all know the copper market is tight, just look at the performance of physical market premiums and inventory balances. For investors to have faith in buying these stocks, they need clarity on trade wars and a U.S./China agreement of sorts. There is no doubt value in the market -- even mouth-watering levels of value in select stocks that investors could not get enough of 10% higher from here, namely Amazon (AMZN) , Netflix (NFLX) , Nvidia (NVDA) to name a few. It just depends on your time horizon. One just needs patience -- and perhaps a gut of steel.