We have noted before that a great deal of performance of the long bull market that began in March, 2009 can be attributed to the demand for stocks created by companies that are buying their own stock back (some analysts believe that they are in fact the only net purchasers of stock). This phenomenon is in full swing in 2018, bolstered by tax reform. While many companies are ramping up capital expenditures, many are also buying back stock -- overall, S&P 500 companies are buying back their own stock at the greatest pace since 1998. The buybacks may be having an effect: the group of the top 20 share repurchasers in the S&P 500 are significantly outperforming the index for 2018 so far. Further, although 2018 has seen significantly more volatility than recent years, it is likely that this volatility has been somewhat dampened by the extent of stock buybacks. Apple (NASDAQ:AAPL) [NASDAQ: AAPL] announced a $100 billion buyback during their reporting of first-quarter earnings, which helped power its stock to a new all-time high.
(The tax reform windfall is giving fuel to buybacks, but they are also being driven by the demand for corporate debt. Since 2009, with interest rates at historic lows, corporations have issued debt and used the proceeds to buy back shares -- helping boost earnings-per-share and allowing management to hit performance targets. That debt in turn has been used, as we noted in the article above, to fuel leveraged debt funds employed by pensions as they attempt to earn their needed 7% returns in an extremely low-interest-rate environment.)
We believe that these trends are likely to continue throughout 2018. We do not believe that buybacks are an infallible key to performance for a company’s stock; some buyback leaders have underperformed the market. On the whole, though, in a period in which the market seems to be unnerved by an endless series of economic, financial, political, and geopolitical worries, buybacks will continue to provide a measure of stability.
Market Summary
The U.S. Economy and Markets
Last Friday the administration presented their drug pricing reduction program. After the announcement the U.S. stock market rallied as it became obvious that the drug policy will not include strict price controls which would disincentivize new drug discovery. Rather, it will be a program that will aim to end the current opaque nature of drug pricing and introduce more competition into the mix. The removal of opacity and stimulation of competition will be the path to lower drug prices.
Overall, since late January, the U.S. market has been plagued by many fears. More and more of them are providing to be phantoms rather than realities. Each rally in the current stock market has occurred after a supposedly frightening event has failed to come to fruition. The most recent was the announcement on drug pricing. Alex Azar, the Secretary of Health and Human Services, is the former president of the U.S. division of Eli Lilly [NYSE: LLY], and he knows in great detail how drug companies, drug distributors, and pharmacy distribution managers act and why they act that way. Their actions are shaped by the existing legislation which has created opacity and lack of clarity. This has allowed gouging, mispricing, and unfair behaviors of many other types.
Secretary Azar knows what to do to lower drug prices and he seems committed to do that. The process of deconstructing the maze of conflicting and opaque regulation will take some time. The hodgepodge system currently in place has been constructed over decades, and will require a thorough remodel to make it more fairly priced and more responsive to the needs of consumers. That process has begun but will take a couple of years to be completed.
World Economic Data and Profits
U.S. economic data remain strong, and the world economy remains positive and growing. China is slowing a bit, but not enough to derail strong world economic growth. We still expect U.S. corporate profits to be up 20% in 2018 and up 10% next year. As we have said before, we expect real GDP growth of 4% for the world in 2018 and 6%+ including inflation. This means that global corporate profits will be up about 10% in 2018.
Foreign Stocks
As we have been noting for months, the key is the U.S. dollar. The current strong dollar is diminishing opportunity in foreign and emerging market stocks. Gold and other precious metals are also under pressure as a result of the strong dollar. We remain bullish on foreign technology stocks listed in the U.S. if they are rapidly growing and serve big markets.
Emerging Markets
We continue to like some major internet retailing, gaming, and social media companies in China. We are not bullish on China in general. Vietnam can be bought on corrections, and we will be buyers of Indian finance companies on market dips as they occur in India. Other that that, we suggest sticking with U.S. stocks, or if you buy stocks abroad in Europe or elsewhere, hedge your currency exposure against the rising U.S. dollar.
Gold
As we mentioned above, the very strong dollar has had a depressing effect on commodities and precious metals. Gold has corrected to support and we would be buyers as soon as the dollar strength begins to dissipate and be replaced with a sideways or weaker dollar. Technically, gold shares are outperforming gold which is a positive for the future.
Cryptocurrencies
The cryptocurrency landscape continues to develop in the direction of tokens structured to comply with appropriate securities regulations. Although Bitcoin itself remains in a trading range, other notable developments are occurring, including the listing of several coins on the Gemini exchange, which has since its inception been in the forefront of crypto entities attempting to set up compliant operations. Particularly noteworthy to us was Gemini’s listing of the privacy coin Zcash [ZEC]. Although the regulatory landscape is evolving rapidly, we believe that Gemini would not take rash action that would jeopardize their standing with financial regulators.
Technological developments are also ongoing in the attempt to solve pressing issues that afflict most cryptos, particularly the problem of scaling -- achieving transaction speeds that could challenge legacy payment networks. A significant test will occur in June when the EOS network goes live and presents a potential challenge to the Ethereum platform.
For those readers interested in digital currencies, we continue to note our basic principles for this type of speculation:
- Only speculate in digital currencies if you are comfortable with the prospect of the complete loss of your capital;
- Focus your efforts on identifying coins with superior development teams, preferably with a track record of successful projects or with significant tech experience, and
- Identify digital currencies which are aiming to solve real problems -- either alleviating issues such as scalability, or applying blockchain technology to a sphere of financial or economic activity for which it is well-suited and where it could genuinely reduce friction and expense for the participants.
Investment implications: Has 2018 been a more volatile year? Yes, it has. But on the bright side, there continue to be many underlying trends supporting U.S. markets. Besides the fundamental economic and financial positives, companies are continuing to buy back their own stock -- and overall, this will continue to have a positive and stabilizing effect on markets. Please note that principals of Guild Investment Management, Inc. (“Guild”) and/or Guild’s clients may at any time own any of the stocks mentioned in this article, and may sell them at any time. Currently, Guild’s principals and clients own AAPL. In addition, for investment advisory clients of Guild, please check with Guild prior to taking positions in any of the companies mentioned in this article, since Guild may not believe that particular stock is right for the client, either because Guild has already taken a position in that stock for the client or for other reasons.