Buybacks Support Healthy Market

07/19/2007 12:00 am EST

Focus:

David Fried

Editor, The Buyback Letter

David Fried, editor of David Fried's Buyback Letter, says the litany of buybacks announced by major companies goes hand in hand with a positive outlook for stocks.

The buyback boom continues unabated, as many boards of directors are jumping aboard. A few of the recent biggies? In the last few weeks, Charles Schwab announced it would conduct a $2.3-billion buyback, Best Buy (the nation's largest consumer electronics retailer) promises a new $5.5-billion stock buyback, Kroger will buy back $1 billion, Target $3 billion, and Wal-Mart $15 billion.

And then, of course, there is the buyback of all buybacks-the announcement by Home Depot of an enormous $22.5-billion buyback. Home Depot's market capitalization before the announcement was about $75 billion, so this new buyback represents 30% of the company's outstanding shares. If completed, this massive plan will rank as the fifth largest share repurchase by a US company.

Because repurchasing seems all the rage, it is even more important to step back and look at the overall economic picture. Underneath the market noise are solid realities that ultimately rule the day.

1. Since 1920, the Standard & Poor's 500 index has gone up an average of 15.5% when inflation was in the 2%-5% range. When inflation topped 5% the S&P average rose just 1.3% per year. Currently, inflation is running well below the 5% mark. The inflation trend remains very positive.

2. The current yield on the S&P 500 is 1.8% while the yield on 30-year government bonds is approximately 5.09%. The difference between the two yields is 3.29%. Additionally, we see the S&P yield rising as companies increase their dividends. So the dividend yield indicator is positive.

3. After 17 consecutive short-term rate increases the Federal Reserve has ended its bias toward rate hikes as rates have remained unchanged for eight consecutive meetings, [making the Fed Indicator neutral].

4. Currently the yield curve is partially inverted. The 30-year bond currently yields 5.09%, 0.11% more than the 4.87% yield on the 2-year paper. The yield curve spread is so small that it is essentially flat, [making the yield curve indicator neutral].

5. The increase in the market so far this year did not increase the P/E ratio of the S&P 500 as earnings have increased as well. The S&P 500 trades at about 18.2x earnings, the lower end of the P/E range that we have had since the late 1990s. [So, the valuation indicator is neutral].

6. The average total bullish percentage readings of Investors Intelligence, Consensus Index, AAII Index, and Market Vane for the month ending June 30, 2007 is 231.85. Readings over 240 have marked market highs over the past few years while readings of about 130 or below have marked market bottoms. The sentiment indicator is negative.

7. The broadest measure of money supply available, M2, is up about 4% from the same time last year. An expanding money supply is bullish for equities. However, this is a very mild expansion.

Three of our seven indicators are positive, one is negative and three are neutral. Our indicators are telling us the investment climate is still mildly positive.

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