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The potential trade war between the United States and China, and the risk of an escalation with not only China but also the rest of the world, has investors on edge.
President Trump is disrupting the complacency in the stock market, but he also did something that has recently been more important. Will it matter?
With imposed tariffs and trade war fears commanding Wall Street’s attention, the Dow Jones Industrial Average suffered its sixth consecutive decline Tuesday. Traders who focus on the Nasdaq 100 which is where you can find Amazon Netflix Apple and Google and those who focus on the small-cap Russell 2000 might be surprised that the Dow Jones Industrial Average has been this weak.
Part of the argument is that some traders think technology and small-cap stocks won’t be hit as hard if a trade war escalates, but we should dig a little deeper.
Aggressive buybacks
This year, corporate buybacks are more aggressive than they have been in years, and technology companies are leading the way. In the most recent earnings quarter, five companies accounted for 75% of the total announced buybacks, and Apple alone accounted for 50%.
The corporate tax cuts and the repatriation of overseas cash, both of which President Trump advocated, influenced corporate buybacks to be very aggressive this year, but they happen every year. Corporate buybacks became popular in 2004. This was true every year except for during the credit crisis of 2008-2009. The average quarterly corporate buybacks were about $145 billion, excluding the credit crisis years.
However, with the added incentives this year, average corporate buybacks have been about $188 billion quarterly. Another way of looking at this is to say that corporate buybacks are $43 billion higher on average on a quarterly basis this year than they have been since 2004. Yet another way of looking at this is to say that corporate buybacks are approximately $14.3 billion higher on a monthly basis than normal.
Liquidity matters
Breaking this down on a monthly basis is important because liquidity matters. If we have a $14.3 billion bid coming into the stock market every month, largely focused on technology, we would expect a degree of resilience in the Nasdaq 100, and that is exactly what we’ve had.
The question is, will these corporate buybacks offset the negative influences of a potential trade war?
The answer is rooted in liquidity, but the corporate buybacks are not the only source of liquidity. Central banks have also given the stock market incredible excess liquidity for years. Central banks are draining excess liquidity the financial system to the tune of $70 billion a month.
Therefore, the real question is, what is more important? Is liquidity more important than tariffs? I think the answer is yes, but either way it leads to the same conclusion. Tariffs are awful, and central banks are poised to drain substantially more liquidity on a monthly basis than the total of corporate buybacks. And that spells trouble for anyone in passive strategies.
Don’t buy and hold. Integrate proactive, risk-controlled strategies, and be prepared for anything.
Thomas H. Kee Jr. is a former Morgan Stanley broker and founder of Stock Traders Daily.