Factset reported that U.S. equity buybacks dropped by almost 7% in the second quarter.
Buybacks have been a strong tailwind for U.S. equities since 2011. It is not clear if there has been a change in trend, but Factset also reported that buyback spending exceeded earnings for 137 S&P 500 companies in the second quarter. This raises question marks about the sustainability of equity repurchases.
Meanwhile, value has continued to deteriorate in the U.S. market. The forward P/E ratio for the S&P 500 has risen to 18, well above the post-1980 average. The median U.S. stock now trades at a record P/E ratio of 21 – even higher than its peak in 2000.
On a more positive note, U.S. EPS excluding the energy sector managed to rise by 1% in the second quarter, consistent with our view that overall EPS growth will turn positive late this year or early in 2017 as the energy drag wanes. That said, the tepid economic outlook means that U.S. EPS growth will only reach 5-6% in 2017, far below current bottom-up estimates.
Bottom Line: Accommodative central bank policies leave the window open to the continuation of the liquidity-driven equity rally in the near-term. We do not see an imminent bear market. Nonetheless, the uptrend is mature and the risk/reward tradeoff is poor, given current valuations and an outlook for sluggish EPS growth. We prefer to focus on capital preservation and maintain a defensive stance in U.S. equities.
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