Submitted by Erico Matias Tavares via Sinclair & Co. [17],
The current equities bull run seems unstoppable. No amount of geopolitical concerns, Greek default fears, rate hikes, US dollar strength, crude oil price volatility, Russian sanctions or whatever else you can think of can put a dent on it.
We got a little cautious [18] in mid-February given some pretty significant divergences with key market internals and credit indicators. For instance the advance-decline line (cumulative weekly up issues minus down issues in NYSE and NASDAQ combined) was suggesting caution, as it lagged the market in making new highs. Since then the S&P 500 advanced a paltry 0.9%, with the Dow Jones Industrial basically flat; the Russell 2000 and NASDAQ were a bit perkier, increasing 2.5% and 3.4%, respectively.
All that churning now seems to be getting resolved to the upside, particularly if we use the advance-line as (an imperfect) leading indicator once again. This is shown in the graph below.

Weekly S&P 500 Index (LHS) and Advance-Decline Line (blue, RHS):
30 May 13 – 24 Apr 15
In fact, in its latest push the NASDAQ broke to new all-time highs – the only major US equity index which had not done so – surpassing the “bubblelitious” peak of 2000. Momentum [19] and breakout traders must all be licking their chops in anticipation of the next big move.
Perhaps we should take a step back and try to understand what is driving this strength. OK, we know that central banks continue to spike the punchbowl, but what is the actual transmission mechanism that directs all this liquidity into equities – as opposed to commodities for instance, which continue to struggle?
Margin debt is of course a prime suspect, just breaking to new all-time highs last March. This enables investors to bid up prices using other people’s money, which is quite typical in bull markets (except that margin debt levels are now higher than the Himalayas).
However, there’s one thing that really stands out: share buybacks by US corporations.
Goldman Sachs, the investment bank, estimates that a cool US$1 trillion in dividends and buybacks will be spent this year by S&P 5000 companies, 13% more than last year. To put this number in perspective, it is almost 50% higher than their combined projected capital expenditures, 4x projected R&D and 5x projected M&A – all new highs for this cycle.
Consider the following table, comparing the S&P 500 and a sub-index composed of its 100 companies with the highest buybacks ratios, from March 2009 (the last major market trough) to today:

Source: McGraw Hill Financial.
The very significant impact of buyback activity on rising equity valuations is clearly evidenced by the strong over-performance of the S&P 500 buyback index relative to the overall market. And this index cuts across all major sectors: as of March, 25% of index constituents were from Consumer Discretionary, 18% from IT, 16% from Industrials, 14% from Financials, 9% from Materials and the balance split between Energy, Healthcare and Consumer Staples.
With corporate bond yields at historically low levels (not to mention sovereign bonds with negative nominal yields), it can make sense for a company to lever up. The increase in leverage reduces its overall cost of capital, which in turn is supportive of a higher equity valuation – provided that there isn't an offsetting increase in the risk of default (an important caveat, actually).
However, despite pumping up share prices, increased buyback activity might not necessarily be a good indicator of sustainable value creation:
- Why are companies spending so much on dividends and buybacks instead of good ol' capital expenditures, R&D or M&A – all activities intended to boost growth? Most likely because managers are not seeing good opportunities to put that capital to work. This should be telling us something about future growth expectations of the market as a whole;
- One thing that is still not confirming recent equities highs is high yield spreads, which remain elevated in relation to this cycle low. While energy bonds may have something to do with it, this is not a great sign going forward, especially in integrated capital markets that are only as strong as their weakest links;
- Buying shares when they are undervalued can be hugely value accretive for existing shareholders; but the opposite applies when they are overvalued. And as we have shown [20], at current valuations increased buybacks might not be such a good deal after all.
But far from us wanting to spoil a good party. There is little any bear can do to counter this barrage of demand. The trend is your friend, and it kinda feels like we are gearing up to move further. Kinda.
[Note: we don’t issue any investment recommendations but if you want to play this, watch out for the powers-that-be who love to fade breakouts at the expense of less nimble investors; in equities, statistics show that waiting for a retracement rather than jumping in right at the breakout provides slightly better risk-adjusted returns.]
That said, all the churning and hesitation at these levels is something to keep an eye on, along with earnings misses, which seem to be on the rise this quarter.
What is truly interesting is the disparity in market analyst expectations, with some seeing a new bubble forming and others a crash of gigantic proportions in the horizon (what is equally interesting is that nobody really knows, so there). A bigger dispersion of outcomes by definition means higher risk – something that investors seem to be forgetting.
Or maybe not. The put-call ratio on the S&P 100 index (based on open interest, not volume, of OEX options) last week hit 2.7x, the highest level we have ever seen since we began tracking this indicator in 2002. This extreme level of downside hedging suggests investors remain very jittery.
This is one heckuva bull market for sure. And a pretty weird one too.
