The bull market in the S&P 500 since March 2009 has been marked by corporations buying back their shares and paying out dividends. From Q1 2009 through Q1 2014, S&P 500 companies repurchased $1.9 trillion of their shares and paid out $1.3 trillion in dividends. During the first quarter of this year, buybacks totaled $637 billion at an annual rate, nearly matching the previous record high during Q3 2007.
As I have often observed in the past, corporations have an incentive to borrow in the bond market and use the proceeds to buy back shares when their earnings yield exceeds the corporate bond yield. That’s been the case since 2004, thanks to the Federal Reserve’s easy monetary policies under both Alan Greenspan and Ben Bernanke, and now Janet Yellen.
Buybacks are a form of financial engineering since they boost earnings per share whether a company’s fundamentals are improving or not. They’ve certainly contributed to the bull market’s great run in an economic environment that has been widely described as “subpar.”
When the next recession hits, corporate cash flow will decline and investors are likely to be less willing to buy corporate bonds. As a result, buybacks will dry up as they did during 2008, exacerbating the eventual bear market in stocks.