Of course, the implications of lowering borrowing costs for the government also extend to lowering borrowing costs for corporations. Although the Federal Reserve hoped that corporations would spend their borrowed dollars on new equipment, human resources, R&D and new products, the majority of those dollars rolled into stock share buybacks. Indeed, share buybacks have played a pivotal role in the current bull market, now in its seventh year.
There are at least three concerns that come to mind about companies that buy back their own shares. First, whether one looks at prices alone or price-tags via P/E and P/S ratios, buybacks have become insanely expensive. Looked at another way, the higher the share price, the more money a corporation is shelling out to acquire the same stuff as they had in earlier years. Literally and figuratively, today’s corporation is getting less bang for its buyback buck.
Second, while overnight lending rates may not affect the longer-term flattening of the yield curve (10s, 15s, 20s), a Fed that looks to maintain credibility may incrementally raise the target at the shortest end of the curve. Borrowers at the 1, 3, and 5 year level may not be as keen to do so, leading the possibility of a slowdown in buyback activity. Such a slowdown could have an over-sized effect on broader equities, creating greater selling pressure than many may be ready for.
Finally, buybacks tend to top out at the worst possible times. The belief that companies know when to buy their stocks low and when to sell them high is erroneous; history suggests the opposite. Buybacks tend to peak when stocks are just about finished reaching for the stars. (Note: Record level of stock buybacks have been reported for Q1 2015.)
Those who may believe that domestic buyback trend will continue unabated, PowerShares Buyback Achievers (PKW) proved its mettle in the current bull market. In truth, PKW has actually outperformed the S&P 500 SPDR Trust (SPY) over the last five years, 134% to 95%. Still, it might make sense to shift international; that is, foreign corporations are now getting the QE-inspired ultra-low rates from both the European Central Bank (ECB) and the Bank of Japan (BOJ). Low volume notwithstanding, PowerShares International Buyback Achievers (IPKW) has been showing similar outperformance trends relative to comparable benchmarks; IPKW has gained more than proxies like the iShares MSCI EAFE Index (EFA) over the las six months.
