Markets

Stephen Gandel is a Bloomberg Gadfly columnist covering equity markets. He was previously a deputy digital editor for Fortune and an economics blogger at Time. He has also covered finance and the housing market.

A crucial tail wind for the stock market's continued bull market appears to be losing its gale. And the one hope to whip it up again is looking increasingly less likely.

Stock buybacks, after years of steadily increasing, are on the retreat. According to S&P Dow Jones Indices, companies in the S&P 500 spent roughly $120 billion on stock repurchases in the second three months of 2017. It's not a huge decrease from a year ago, but it's the fifth consecutive quarter in which the trailing 12-month figure for buybacks has dropped, the first time that's happened since the market meltdown in the Great Recession.

Buyback Backtrack
After steadily increasingly for years, companies are devoting less money to repurchasing their own stock
Source: S&P Dow Jones Indices

Buybacks have been a big component of what has propelled the current bull market, though less so recently. Yet there is a pretty good reason stocks, which are again up 12 percent so far this year, have been able to weather the recent buyback pull: earnings. Stock repurchases, which boost earnings per share by lowering the per-share part of the equation, were key to propping up EPS during 2015 and 2016, when earnings growth was lacking. Profits have roared back this year, recording double-digit gains in both the first and second quarter, making buybacks less crucial. That may be changing.

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The average bottom line of companies in the S&P 500 in the third quarter is expected to advance only 4.5 percent from a year ago. That's a third of the advance in the first three months of the year. Profit growth is expected to rebound to 11 percent in the fourth quarter, but Wall Street's projections have been falling recently, especially the closer we get to announcement season. Projections for the third quarter, for instance, were as high as 7.5 percent in June.

None of this is a problem if buybacks snap back, and until recently most people expected they would. But the force that was supposed do that -- corporate tax reform -- seems more and more remote. Earlier this year, Goldman's chief U.S. economist, David Kostin, predicted that any tax deal that included a repatriation holiday for companies that hold cash overseas could increase repurchases by $150 billion this year or next. Others were even more optimistic.

But recently, despite some signs of dealmaking between President Donald Trump and top Democrats, Wall Street is sounding more pessimistic on tax reform. On Friday, analysts at brokerage firm Keefe, Bruyette & Woods wrote that any cut in corporate levies that did make it through Washington, in the face of disagreement even among Republicans, would come later and be more limited than earlier predictions. And even if a deal happens, some are skeptical it could even be much of a boost for buybacks. A research paper posted last week on the National Bureau of Economic Research found that tax laws were only one explanation for the decades-long growth in corporate cash.

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On top of all this, companies seem all of a sudden to be price sensitive when it comes to buybacks. So the stock market's lofty level could be limiting share repurchases as well. What this adds up to is that the recent drop-off in buybacks is likely to continue. And that means one of the engines of the stock rally is going to be reviving a bit less. That's probably not enough to send the market into reverse, but it could be enough to slow the advance. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Stephen Gandel in New York at sgandel2@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net