Your Tariff-Free April Mailbag

Tariffs are understandably hogging headlines this month, but there are other things going on. Although we had to sift through quite a few queries on tariffs, we found a few yielding fresh topics to hit. Here we go!

Do stock buybacks affect markets?

Yes and no? Stocks move on supply and demand. Stock buybacks, where a company buys its shares and takes them off the market, theoretically reduce supply. They can also raise earnings per share, thus rewarding shareholders. So, all else equal and on paper, stock buybacks are bullish.

But reality, as always, is more complicated. Buybacks are just one factor affecting supply. There are others, and demand matters, too. They may not even reduce supply if they merely offset secondary issuances, like employee stock awards. A lot of times, buybacks merely “sterilize” new issuance, if you will pardon the jargon. Or, other negative (or less bullish) fundamental factors might matter more to pricing, lowering demand even as supply shrinks. So buybacks are a factor, but not the factor.

S&P produces an index tracking the 100 S&P 500 stocks with the highest buybacks. It is an equal-weighted index, so best to compare it to the equal-weighted version of the S&P 500. The buyback index’s trailing 10-year annualized return is a bit ahead, but we wouldn’t read into that. Its sector composition differs wildly, so you can’t definitively say buybacks are the swing factor driving higher returns. To us, the difference is an interesting observation, little more.

You often say stocks move on economic, political and sentiment drivers. Do any of these three matter more than the others?

Not in our view—they all work together. Political factors (regulatory changes and whatnot) affect economic results, and sentiment helps us gauge how much the good or bad on both fronts are priced in to markets. You can’t really isolate any one.

Here is an example. Let us say Congress is mulling a tax or regulatory change that would affect the long-term profitability of a business endeavor you are considering launching. You don’t know what they are going to do, but you do know that if they pass this thing, you will have to do things differently than you would under the status quo. So, with this regulatory uncertainty looming over you, you wait. The economy doesn’t get your investment. And you are a little frustrated that no one notices this is happening.

Here we have a political factor carrying direct economic implications that people broadly don’t see—multiply that across thousands upon thousands of businesses, and you get a recession that stocks aren’t braced for and have to price in. All three drivers worked in concert.

Or, how about this. You are still a small business owner. Congress is raising your taxes, yuck. But you notice that this has hit sentiment hard, making everyone fearful of recession, and interest rates dropped. You have been thinking for a long time about opening a second location. The higher tax rate won’t wipe out your profits, and now you can borrow really cheaply to make it all happen. So you go for it, the economy gets your investment, and you are giddy that you knew something those silly headlines didn’t.

Here, we have a political factor whose alleged economic implications were overblown, secretly paving the way for you to do some economic stimulus. Multiply this across thousands upon thousands of businesses, and you get a boom that stocks then have to price in … in a good way. All three drivers again working together.

As with a lot of things in investing, it is the totality of these three drivers that matters. Which makes it kind of fun for us, thinking through how all the cogs in the machine affect one another.

You are quite bullish on Europe, which has lagged for years. What do you see the region doing differently now?

Nothing much—it is more about how sentiment toward the region has evolved, in keeping with our prior question. Yes, earnings are expected to improve and firms’ and consumers’ balance sheets in Europe are healthy. Eurozone economies are still grinding along, their politics are still gridlocked, and the major systemic questions arising from last decade’s debt crisis haven’t resolved. However, sentiment is key. It got too low there, to a point where just-ok or not-as-bad-as-feared results can deliver big positive surprise. Even much-maligned Germany, the region’s proverbial “sick man,” enjoyed soaring stock markets before this spring’s correction.

In our view, this is kind of the ideal backdrop. If eurozone nations were launching massive economic reform initiatives, increasing competitiveness and cutting red tape—or launching big public investment campaigns—then sentiment could heat up, creating room for disappointment when things didn’t go as well as feared. Similarly, if economic growth rates were red hot, and everyone noticed and penciled in more of the same, expectations would be hard to beat. Fast growth would get priced in, and the region might underperform. Unloved for no good reason is often a sweet spot. 

Do you watch the news and just roll your eyes?

On the rare occasion we watch it rather than read it, yes, but not constantly, and maybe not for the reasons you think. We have largely priced in the heightened rhetoric, bad fashion, heavy-handed makeup and ideological/partisan bias. These things have always been present, even if society misremembers the mid 20^th century as some objective golden age. We also enjoy a good local human-interest story as much as the next guy or gal. Some of us have vivid memories of being so excited when our grade school catapult contest made the local evening news, and we still remember when the 10 PM anchor was that good-natured cut-up in the back of the classroom in fifth grade.

We save our eye-rolling for something specific, and it is universal across all financial and economic coverage—print, television, radio, podcasts, social media. That is: The chronic acceptance and portrayal of theory as fact. Friends, all of the following are theories or suppositions:

• High interest rates hurt economic growth, while low interest rates help it.
• Tax cuts fuel inflation.
• Low unemployment causes higher inflation because it raises wages.
• People spend less when the stock market is falling.
• High gas prices will hurt consumer spending.
• High budget deficits hurt the economy.

We could go on, but you get the drift. Over and over again, news coverage of markets or the economy will say things like this offhand, stating them as fact. These statements often aren’t the focal point, but part of the explanation of why A will allegedly cause B and therefore be good or bad for the economy and markets. The problem is, none of these things are actually fact. They are suppositions, claims, opinions, theories—and all easy to test against data. But few actually do. Our fearless founder and Executive Chairman, Ken Fisher, wrote a whole book about that nearly 20 years ago.

Called The Only Three Questions That Count, it handily gives us a silver lining to all the eye rolling. Because people don’t think to test these claims or the assumptions they support, there is an advantage for those who take the time to do so. They might find a spot where everyone is wrong, and there may be investment opportunities in positioning portfolios for that. We highly recommend giving this questioning a try. Like us, you might find it is actual fun.