3 Reasons Why Buyback ETFs May Lose Momentum

Though U.S. companies repurchased $1.7 trillion of their own stock during 2012–2015 (as per Goldman Sachs (NYSE:GS)), the activity is going downhill this year. According to TrimTabs Investment Research, U.S. stock buybacks dropped 21% in the first seven months of 2016 from the comparable year-ago period.

Not only buyback, even dividend-per-share growth is likely to cool down from 9.3% in 2015 to 5.5% this year according to BCA. Let’s find out why the binge has lost luster and what’s expected ahead.

Fed to Hike Rates

With a low interest environment commanding most developed economies including the U.S., buyback gained precedence. But the Fed enacted a liftoff in December 2015 and may enact another one by this year end. Already, U.S. Ttreasury yields are rising on the Fed hike prospect. So, accessing the debt market to finance buyback would not be an easy task in the coming days (read: Prepare for Rising Rates with These Inverse & Hedged Bond ETFs).

Dwindling Cash Piles with Corporates

Burdened by a year-and-a-half of flagging profitsand expenses on activities like buybacks and dividends,U.S. companies have now started to see leakage in its huge cash loads, as per Bloomberg. Cash and equivalents dropped to a median $860 million for the S&P 500 Index members in Q2, reflecting a three-year low level.

In fact, half of the total cash is sitting with the top 50 wealthiest companies on the index. But the rest are seeing cash gushing out “at the fastest rate since the start of the bull market.” Earnings recession for six quarters in a row was responsible for this cash exhaustion. Quite expectedly, the dearth of sufficient cash will limit stock buyback activity. lack

Overvalued Market?

A meaningful slowdown in share purchases can be the result of overvaluation in markets. At an inflated level of share price, companies are perhaps shying away from buying back their own shares.

Investors should note that the S&P 500 hit all-time highs several times this year to start Q3 despite the ongoing earnings recession. Several analysts are of the view that U.S. equities are overvalued at the current level. With still-tepid U.S. economic recovery, corporate recession and the presidential election in November, markets are hovering at lofty levels.

Needless to say, companies will not repurchase their shares at higher prices than what they are actually worth (read: Believe in George Soros? Short S&P 500 with These ETFs).

How Have Buyback ETFs Performed This Year?

There are a couple of ETFs that focus on this niche strategy. PowerShares Buyback Achievers Portfolio PKW looks to track companies that have implemented a net reduction of 5% or more in shares outstanding in the last 12 months. PKW is up 2.3% this year but lost over 2.8% in the last one month (as of September 13, 2016). The performance of PKW is weaker than SPDR S&P 500 ETF (AX:SPY) which hasyear-to-date returns of 4.6% and one-month losses of about 2.7% (see Total Market (U.S.) ETFs here).

Another buyback ETF SPDR S&P 500 Buyback ETF (AX:SPY) , which measures the performance of the top 100 stocks with the highest buyback ratios in the S&P 500 in the last 12 months, has gained about 5.3% so far this year. However, the fund has lost over 1.7% in the last one month (as of September 13, 2016).

AdvisorShares Wilshire Buyback ETFTTFS has added about 6% so far this year and was off 2% in the last one month (as of September 13, 2016). Investors should note that the performance by SPYB and TTFS was relatively better than SPY (NYSE:SPY) (read: New Float Shrink ETF on the Horizon from TrimTabs?)

Any Hope Ahead?

Investors should now be cautious while playing buyback ETFs given the looming concerns. If the broader market slumps ahead echoing what several analysts are foreseeing, the ongoing concerns about high equity valuation should fade out gradually, bringing back the buyback fervor.

Plus, corporate earnings are slowly returning to health with the S&P 500 likely to see a 2.8% decline in earnings for Q3 and then moving on to the growth territory from Q4, as per the Earnings Trends issued on September 2, 2016. As per the report, the S&P 500 will likely see 5.2% earnings growth in Q4, 11.3% in 1Q17 and 10.4% in 2Q17. If this happens, cash positions should recover gradually.

However, things might take time to settle down before the buyback zeal returns and the related ETFs are back in form.

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