Stocks ended the week marginally higher as U.S. economic data continued to generate positive headlines. Though regional manufacturing surveys around the U.S. are showing improving growth, retail earnings this week were mixed as some companies cited that delays in tax returns were effecting spending as tax refunds are running $60 billion below average thus far this year.
Hopefully this isn’t a prophetic headline for the U.S. equity markets – actually, the story is about a real live bull’s demise. However, one can argue that the market has figuratively been a runaway bull. Since the bottom in March 9, 2009, U.S. stocks have been the best performing global asset class, yet have been the least loved. Since March of 2009, investors have pulled nearly half-a-trillion dollars out of U.S. equities. The chart above highlights the monthly fund flows into U.S. domestic equity mutual funds and ETFs. For the most part, flows have been out of U.S. equities, while the market has gone up.
So why have stocks been rallying while investors have been selling? The answer is company buybacks. Bernstein Research estimates that companies have announced over $500 billion in share buybacks in the U.S. in 2016, which is down from $650 billion in 2015. Shares outstanding for large cap U.S. companies are hitting record lows. CNBC highlighted this occurrence earlier this week with a piece by Bob Pasani. With company margins at record highs, and cash generation remaining healthy, we expect this trend to continue. Finally, if there is a repatriation tax holiday for U.S. companies they could bring up to $2 trillion of cash held overseas and these buybacks would continue.
It’s been over a month since the inauguration of our forty-fifth president and the momentum in equity markets has continued. Post-election, stocks rallied over 5 percent into the end of 2016. Our outlook for 2017 was somewhat cautious due to muted earnings growth, uncertainty over new fiscal policies as well as valuation concerns. What has been a major surprise is the lack of volatility in the markets. Policy and economic uncertainty has not translated into stock market volatility. For instance, it has been 54 days since stocks have moved either up or down more than one percent in one day. It has been since October 11 since the market has sold off over one percent in a day. Historically, when equity volatility is this low, it has resulted in above average returns. The chart below shows how often moves up/down more than one percent occur during each year.
When the markets exhibit low daily volatility, it is usually during periods of strength. Note the mid-80s, mid-90s, and mid-00s. Even over the last four years, the S&P 500 is up over 75 percent. This is a 15 percent annualized return which is 5 percent greater than the long-term average.
We continue to be surprised about how complacent the markets seem to be with uncertain fiscal policy, low global economic growth and valuations that aren’t cheap. Our 2017 outlook was focused on corporate earnings growth being a “show me” story, but investors aren’t waiting for the results, they are buying now in anticipation of good news.
Our Takeaways for the Week:
- Investors have finally embraced the equity rally which may lend further support to the pick up
- Low volatility historically has been a positive for future returns, but earnings growth cooperation remains to be seen