American companies could start buying up more of their own shares as rising profits generate surplus cash and interest rate cuts come into view.
Stock buybacks struggled to recover last year after taking a hit in 2022, even as corporate earnings began to rebound. Strategists at Deutsche Bank predict that could change soon, but even at their current subdued pace, buybacks should help drive 7% to 8% annual returns in the S&P 500 index.
Investors view buybacks as an indication that a company's leadership believes its own shares are undervalued and are confident about its future performance. Buybacks also tend to push up share prices due to the added demand.
When the Federal Reserve's interest rate hikes in 2022 clobbered the stock market and corporate earnings, S&P 500 company buybacks also fell from about $300 billion in the first quarter to $200 billion by the fourth quarter, according to Deutsche Bank.
About three weeks into 2024, some firms have already announced plans to buy back their shares. Home construction firm Lennar on January 9 raised its share buybacks by $5 billion. ONEOK, a natural gas company, on Wednesday unveiled a $2 billion share repurchase program.
"The key reason buybacks remain subdued is the continued overhang of cyclical uncertainty with the consensus of economists steadfast in their forecast for a sharp and imminent slowdown," Deutsche strategists wrote in a research note on January 12. However, "further increases in earnings as in our forecast should prompt increases in buybacks."
Still, waning but persistent inflation and the Fed's continued fight to tame it could continue to divert cash away from buybacks to financing more pressing costs.
Big banks, for example, were hit with a one-time charge by the Federal Deposit Insurance Corporation during the most recent quarter related to the collapses of several regional banks last year.
An index that tracks the performance of the top 100 stocks in the S&P 500 with the highest share buyback ratios is down about 2% so far this year. The wider index is up by 0.8%.
"Given the market's expectations for interest rates to decline even as higher-for-longer interest rates continue, companies may be shy of financing buybacks going forward as discretionary buybacks may need to be financed from ongoing operations," wrote Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, in a note last month.
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