Short-term savior or longer-term source of instability?
Investors are facing that question after the dust settles on last week’s historic market rout, which saw $1.25 trillion in value wiped from U.S. equities in a single day. While fingers are being pointed at systematic strategies and volatility-linked products, a larger and more plain-vanilla culprit may be lurking in the form of share buybacks that have come to characterize the market in recent years.
"The pullback coincided with the blackout period for share repurchases, likely intensifying the decline," analysts led by Goldman Sachs Group Inc.’s David Kostin wrote in a research report. "Given corporations represent the largest single source of demand for U.S. shares, equity returns have typically been lower and volatility higher during blackout periods."
As companies exit blackouts that prevent them from buying shares ahead of publishing earnings, one source of equity demand should return to help support the market, they said. While that should provide short-term help to an equity market still struggling to find its footing, it could also revive a longstanding debate about the quality of a multi-year rally during which companies have taken advantage of low interest rates to buy back shares.
It’s a viewpoint espoused by Chris Cole of Artemis Capital Advisers. While he’s long warned of the potential for roughly $2 trillion in volatility-linked products and "implicitly short-vol" strategies — essentially, bets that the market will stay calm — to blow up, he cautions they’re far outweighed by the $3.8 trillion of shares bought back by companies since the financial crisis that are also part of the global “short-vol” trade.
"You’re leveraging the company up — which means that you’re exposed to interest rates, you’re exposed to market stability. And then you’re buying back your shares, resulting in a price-insensitive buyer that is always underneath the market, resulting in this price-insensitive buyer always buying on market dips," he said in an interview with MacroVoices.com. "The result of this is that you’re artificially reducing realized volatility. The strategy is always to buy on dips."
According to Goldman’s proprietary data, the notional value of share repurchases by corporate clients surged to the highest level since August 2015 on Feb. 5, as companies exited blackout periods and stepped into the market to buy back their shares on the cheap.
"I don’t think what I’ve really talked about has come to pass yet. You know The VIX ETPs [exchange-traded products tied to the VIX forward-looking volatility index] are really the smallest portion of the global short-vol trade," Cole said in a subsequent interview. "This is just the appetizer for the unwind that is about to come."