The big story this week was the Turkish currency meltdown and potential contagion to the Eurozone. The lira fell at one point -35% against the U.S. dollar. Can we blame Trump for this also? There has been escalating tension over the detention of an American pastor, with Trump ordering some tariffs on Turkish metals to be doubled. The carnage has quickly spread from emerging to developed markets: The euro sank as much as 1.2 percent to the weakest level in more than a year, extending a drop triggered earlier by a Financial Times report that the European Central Bank raised concern about European banks’ exposure to Turkey. And when banks have exposure to bad assets (subprime), capital markets tend to get unsettled. President Recep Erdogan’s speech on Friday did little to quell investor angst that Turkey’s crisis will spread to other economies. The markets will have the weekend to think about it. We are not too alarmed. We saw this same knee-jerk reaction with the Brazilian real in May 2017 on political discord. Political events are generally creators of buying opportunities.
Macroeconomic news this week featured price data. CPI continues to run above the 2% level (+2.9% y/y for July). The core measure of the Consumer Price Index, which excludes food and fuel, rose 2.4 percent from a year earlier, the biggest advance since September 2008. Producer prices PPI also stayed near 7-year highs (+3.3% y/y in July). Again, inflation is not a worry with the central banks looking to experiment with letting inflation run hot.
Squaring Insider Selling & Company Buying
Investors, especially those with a technical focus, look for internal divergences with the market to signal a major trend change. Rising prices with narrowing market breadth, higher prices on falling volume, and momentum oscillators (such as the RSI) diverging from price are just a few examples. Today, we see a very curious and quite unusual divergence within financial markets: record insider selling by company executives met with record stock repurchases by company treasuries. That is a concern.
Insider selling is particularly poignant in light of the corresponding levels of company buy-backs. Indeed, on the one hand executives are using company cash to withdraw shares from the market (boosting stock prices) while with the other hand dumping their personal stock holdings via massive insider sales.
Just as impressive as the current ratio of insider sales relative to insider buys (19.5-to-1 ratio) is the amount of insider sales to company treasury buy-backs. Over the past year, considering all U.S. companies (all market caps, all sectors), there have been $86.27 billion dollars in stocks sold by company insiders. Over the past six-months, the amount is $43.6 billion dollars, demonstrating the continued steady pace of insider selling in 2018. Looking at total company share buy-backs, in Q1 2018, we saw $242.1 billion and almost double that amount in Q2 2018 ($433.6 billion). While Q3 numbers are not yet final, we expect at least another $400 billion in company buy-backs. Our estimated annual buy-back rate is between $1.3 trillion and $1.6 trillion. In other words, massive executive sell- orders are being filled by their company share buy-back orders on the secondary markets.
We looked at the historical data from 2007, the final year of the prior economic expansion and bull market. Until 2016, the prior record for company buy-backs on an annual basis was $589.1 billion, set in 2007. The pace of buybacks at the time was partially driven by companies supporting their stock during the opening downturn of the year, which coincidentally started in early February when many earnings lockups ended. In 2018, we also saw company buying during the February correction (which likely saved equities from a bear market). But this time around, company buying has been sustained both before and after the equity correction. Indeed, one unique feature of company buying today is the price agnostic aspect (companies are spending their cash to purchase and retire overvalued shares). Meanwhile, insider selling was much less pronounced than today. Company executives also miss-judged the severity of the Subprime Crisis. For $589 billion in company buying in 2007, the year only saw $15.6 billion in insider selling. In other words, we saw less than one-third the level on insider selling in 2007 relative to company buying, compared to 2018. This should be worrying to market participants. If company executives, clearly the smart money in the market, are selling their shares this much more aggressively in 2018, we would have to assume that they have a better understanding of the economic situation of their company, and their share valuation, than they did in 2007.
Looking specifically at companies with strong insider selling, we find the likes of Facebook, Hilton, and Lululemon.
We took this Top 20 list of companies seeing the most insider selling and looked at the WMA Valuation scores for these companies (composite of Enterprise Value/sales & Enterprise Value/earnings). These are relative rankings, with the most attractively valued companies having a score closer to 100.
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The mean Valuation score is 59.4, so the above average represents companies in the bottom half of our valuation rankings. While the market is turning a blind eye to valuations in the pursuit of momentum stocks, company insiders seem to be much more value conscious than the market. While some companies may have company-specific financial issues, we feel that the record level of insider selling at $86.27 billion over the past year represents, globally, executive awareness of unsustainably high stock valuations.
The Facebook Farce
The highest profile company in our list above is Facebook. Even to the casual market observer, to learn that the company CEO and founder is selling his personal shares by the billions while Facebook’s board is simultaneously buying back shares by the billions on the secondary market must seem incongruous.
Facebook reported buying $9 billion worth of Facebook outstanding shares on April 25, 2018. Prior to the 2018 repurchases, Facebook reported buying $6 billion in January 2017.
This relatively hefty buying ($15 billion out of a company with a total market cap of $523 billion) contrasts with Mark Zuckerberg’s personal selling. Below are the reported SEC Form 4 filings for Zuckerberg. We see a steady stream of selling. $4.77 billion sold by Zuckerberg this year (up to and including August 8) and $9 billion bought by the company. And appropriately enough, Facebook’s shares have kept rising this year behind the Facebook treasury purchases and the inattention of investors to Zuckerberg’s selling.
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Buy-Backs Are All That Is Left
With the stock market at historically high valuations and earnings near the cycle peak, one of the only ways to keep stock prices rising (outside of added monetary or fiscal policy stimulus) is to lower total shares outstanding.
While buy-backs have characterized this entire bull market, due to the central bank liquidity programs, the real buy-back craze began in the second have of 2017 with the Trump corporate tax cut. We felt at the time (and still do) that a massive fiscal stimulus program nine years into an economic expansion is more than misguided policy. It is reckless and will cause economic hardship for years in the future. Keynes taught us to use counter-cyclical fiscal policy (cut taxes and induce federal spending at the depths of a recession). Firing all our fiscal policy bullets at the cycle tops leaves fewer policy options once the next recession/crisis hits.
Company Buy-Backs are getting a tail-wind from Trump’s policy. Companies are taking advantage of the tax breaks to repatriate money from abroad. What bothers us is the unproductive use of all the cash on company balance sheets now. Instead of investing productively in Capex or improving worker salaries to a greater degree (admittedly some companies did distribute tax savings to workers) companies are purchasing their own shares at the most expensive levels in history.
While the broad U.S. equity market buy-back frenzy began in the second half of 2017, the five largest companies (which we call the Big 5 – Apple, Microsoft, Amazon, Google and Facebook) have been buying back aggressively since 2014.
Not surprisingly, this bid put under the market from company treasury buying sent these stocks soaring. We have been following the performance of the Big 5 versus the other 495 stocks in the S&P 500. The updated chart below is phenomenal. The de-correlation of the Big 5 stock prices with the rest of the market corresponds with the acceleration of their buy-back programs from 2013 onwards.
Conclusion
Getting back to our initial interrogation, how long can this internal divergence between insider selling and company buy-backs last? If, as is the case with other forms of market divergences, this dichotomous selling with one hand and buying with the other could very well be indicative of a market top. Readers should continue to “follow the money”, so to speak, and remain vigilant as insiders are apparently scamming the markets with these double dealing share transactions.