30 January 2017
Over the past week Australian shares were 1% higher. Shares in developed countries were 1.2% higher with the US market 1% higher. Shares in emerging markets gained 2.5%. The Australian dollar was 0.1% lower at 75.52 US cents. The 10 year bond yield in Australia was unchanged at 2.78% while in the US, the 10 year bond yield closed the week 0.02% higher at 2.48%. The oil price gained 1.4% to 53.17 US dollars per barrel.
It would be nice to think that share markets operate the same way as each other but unfortunately they don’t. For example, some differences are created by the different tax systems in place for each country. Tax treatment of capital gains and dividends varies across countries. This naturally changes the way that companies manage their capital.
Australian companies have historically paid a high proportion of earnings as dividends, partly due to our franking credit system.
The market structure differs in the US. Generally companies have historically paid low dividends but undertaken a large amount of share buybacks or ‘stock repurchases’ in US market jargon. A share buyback is where a company uses its own capital to purchase and then cancel its own shares. If done in a sensible manner this should lift share prices because the company’s earnings per share will be higher. This is because the earnings are largely unaffected by a share buyback and there are now less shares on issue. This makes the company more attractive to investors.
The chart below details share buyback activity of US companies on the Standard & Poor’s (S&P) 500 Index.
We can see that buyback activity fell during the Global Financial Crisis but has recovered strongly.
It’s important to be aware of buyback activity when generating market forecasts. It’s also relevant to understand what’s motivating companies to repurchase shares. High buyback activity could indicate that companies see few growth opportunities and so buying back shares is the most responsible way for them to manage their capital. Alternatively it could also represent irresponsible behaviour if companies are conducting aggressive levels of buyback activity to generate short term share price performance.