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Did Stock Buybacks Fuel the Market Rally?

Neena Mishra

U.S. companies continue to splurge on their own shares. Per S&P, share repurchases increased to $128.2 billion during the Q3 2013, up 8.6% from the Q2 and up 23.6% from Q3 of 2012.

With record amount of cash on their balance sheets, companies are increasing both dividend and buybacks but buybacks portion has been growing faster than dividends.

Investors generally prefer dividends to buybacks as they are simpler to understand and put money in the pocket. However, buybacks have their own advantages—they reduce the outstanding share count and thus increase earnings per share.

Buybacks generally represent a vote of confidence by management in the company's stock. But at the same time, returning more cash to shareholders also implies that companies are not able to deploy their cash in a more efficient manner. Lack of confidence in the economic recovery coupled with fiscal uncertainty may be restraining companies from stepping up hiring or capital investments.

Availability of cheap money also encourages companies to spend more on buybacks. Rising interest rates may lead to a slowdown in the buybacks activity.

Per PIMCO’s Bill Gross, “Stocks have their own QE: corp buybacks” at $500 billion a year. They are a main reason stocks go up. When do THEY taper?”

Here is a chart from FactSet that shows the correlation between buybacks and S&P 500 index.

My RTI questions are 1) Were buybacks a main factor behind the stock market rally? And 2) Will be slowdown in buybacks hurt the rally?

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