• Share repurchases are the 'sole demand' for U.S. equities
  • Hedge funds are growing more risk averse, Kostin says

Corporate buybacks are the only thing underpinning demand for U.S. equities, and were the reason stocks bounced back from their worst January in seven years, according to David Kostin, the chief U.S. equity strategist at Goldman Sachs Group Inc.

A pause in share repurchasing, combined with plunging oil prices and concerns over China, fueled the 5.1 percent drop in the Standard & Poor’s 500 Index last month, Kostin said in a Bloomberg Television interview. U.S. companies now are jumping back in with fresh cash, he said. The benchmark index rallied 2.8 percent last week for its best performance of 2016.

“Corporate buybacks are the sole demand for corporate equities in this market,” Kostin said. “Now in February, when companies are clearly repurchasing significant amounts of stocks, the authorization for new buying is up at record high levels. That’s a key dynamic in the market from a money flow perspective.”

In the month following the end of a calendar quarter, companies tend to enact a blackout period and restrict share repurchases, he said. With earnings season wrapping up, buybacks have resumed, reviving a reliable source of U.S. stock demand. The dynamic is creating a pattern where a stronger February follows a weak January, Kostin said.

Returns reflect that difference. An equal-weighted S&P index of companies buying back the most shares has climbed 0.9 percent in February, compared with a 0.3 percent decline for an equal-weighted version of the S&P 500. With corporate purchases limited in January, the buyback index underperformed the equal-weighted measure by 1.4 percentage points.

Yet the share-enriching influence of buybacks hasn’t been enough to keep hedge funds from growing more risk averse amid a rout in crude oil and speculation China’s growth will continue to slow, said Kostin.

“It’s been a very challenging market this year in terms of some of the macro rotations, concerns about China, and oil, which has encouraged fund managers to reduce their exposure,” Kostin said. “They’ve brought in risk from a material way relative to where they’ve had peaks in the past.”

Hedge funds have been selling a large portion of their holdings, dropping net long exposure to 45 percent, the lowest since 2012, according to Goldman’s most recent “Hedge Fund Monitor.”

They’ve also reduced the number of stocks held in attempting to cope with the choppy market, Kostin said. Hedge funds’ top 10 holdings made up 68 percent of their long position, the highest in Goldman Sachs data going back 15 years.

Kostin expects the S&P 500 to end the year at 2,100, implying a gain of 9.3 percent from Tuesday’s closing level of 1,921.27. His forecast is 2.7 percent below the median in a Bloomberg survey of 21 strategists. He tied for the most accurate forecast for the S&P 500 last year.

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