Monthly Archives: April 2020

Share buybacks and the economic cycle

18 Saturday Apr 2020

Posted by in Equity

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This is my reading of an excellent paper by S&P Global, “Examining Share Repurchasing and the S&P Buyback Indices in the U.S. Market” by Liyu Zeng and Priscilla Luk, March 2020.

Over the past 20 years (up to end of 2019), the S&P 500 Buyback Index had outperformed the S&P 500 in 16 out of 20 years, or about 5.5% per year. YTD, it has underperformed, though, by about 14%! With that it, has managed to erase the last 10 years of outperformance! 

We had similar underperformance of the buyback index in the early stages of the last financial crisis, in 2007; while in 2009, the S&P 500 Buyback Index had a significant excess return. Make your own conclusions where we are in this cycle.

Reality is that “buybacks tend to follow the economic cycle with increased or decreased repurchase activities in up or down markets while dividend payouts are normally more stable over time, the S&P 500 Dividend Yield portfolio tends to outperform in down markets, while the S&P 500 Buyback Index may capture more upside momentum during bull markets.“

Almost all of tech, financial sector and consumer discretionary companies engage in share buybacks. Less than 50% of utilities do (but they all pay dividends). As share buybacks tend to congregate in cyclical rather than defensive sectors, the buyback index tends to underperform during recessions (this year).

Since 1997, the total amount of buybacks has exceeded the cash dividends paid by U.S. firms. The proportion of dividend-paying companies decreased to 43% in 2018 from 78% in 1980, while the proportion of companies with share buybacks increased to 53% from 28%. 

Compare to other developed markets. Despite an increase of share repurchases in Europe and Asia, as a % of all companies, buybacks still stand at about half that in the US. On the other hand, fewer Canadian companies engaged in share buybacks during that period. 

For the S&P 500 Index, over the last 20 years, 2/3 of the total return has come from capital gains and only 1/3 from dividends. Before the mid-1980s, when buybacks became dominant, the opposite was true. Buybacks have been instrumental in driving equity returns since the mid-1980s.

What to expect from a potential 10-15 mbd OPEC++ cut

03 Friday Apr 2020

Posted by in Energy, Uncategorized

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After yesterday President Trump tweeted about it, there is today continuous noise about a possible OPEC++ (global coalition of all crude oil producers) meeting next week with the expectations of substantial cut in production, anywhere between 10 to 15mbd. On one hand, if this materializes, it will be an unprecedented (not counting the 1970s oil embargos). On another, it will barely go to match the lost demand from the (almost) whole world going on economic standby for at least a month, maybe much longer on the back of COVID-19.

Let’s put this into context. We got a 25% decline in oil prices (from low 40s on WTI to low 30s) when Saudi Arabia and Russia (OPEC+) could not agree on a 1.5mbd cut a month ago, and Saudi instead announced they ‘might’ increase production by 1.5-2mbd (but as of yet they really haven’t). Arguably, if they had agreed on a cut, oil prices may have rallied a bit, maybe to mid or high 40s.

But then we got another 30% decline (from low 30s to low 20s) when the negative effect of COVID-19 on demand became more evident. In an alternative reality if OPEC+ deal had happened a month ago, prices could have then collapsed to the low to mid 30s (30% off mid to high 40s). Don’t forget that oil had already sold off about 30% YTD at the time of pre-OPEC+ no-deal weekend. These are the milestones to keep in mind when considering the scenarios ahead of a possible crude production cut in the next few days. 

So, this is the way I am looking at this:

  1. The likelihood of ‘everyone’ (not just Saudi and Russia, but OPEC++) really agreeing on a 10-15mbd cut is very close to nil;
  2. But the likelihood of a ‘fudge’ agreement is very high.

‘Everyone’ benefits from a ‘deal’, even the oil importers as crude has become the main sentiment indicator and that would help risk assets: OPEC++ could decide to announce a ‘deal’ simply to stabilize the market with the idea that no one is expected to really cut production (perhaps negative effects of COVID-19 eventually wear off and demands comes back0.

Reality is that, in a similar manner to Saudi Arabia not really ‘wanting’, or, arguably, even being unable to hike production by 2mbd (they have never really managed to sustain production above 12mbd), no one really intends to, or is willing to go the other way (cutting production may actually entail lost capacity for ever). So, in both cases, everybody is playing the waiting game and hopes to do nothing. But the trick is in delivering the right message.

But what could happen to crude prices if there is an announcement of a 10-15mbd cut?

One would expect that the low range point of a bounce would be the low-to-mid 30s on WTI (where prices would have been, had a cut happened between Russia and Saudi Arabia a month ago, and the demand lost we can project at the moment from COVID-19). We are just above 30 on WTI as of right now, on Friday close. But given the much larger cuts this time, the high point of the range could indeed be the low 40s where prices were before the Russia – Saudi deal fiasco.

What happens if there is not even a ‘fudge deal’ in the coming few days? We go back to the low 20s immediately and then we wait to see how much more demand is destroyed.