This infographic is available as a poster.

Chart: The Rise of Stock Buybacks Over 20 Years

Despite market turbulence, stock buybacks are on track to hit record levels by year-end.

Spurring this wave of buybacks are strong corporate cash flows⁠—sitting near $2 trillion—and a 1% excise tax on buybacks approaching in 2023. This signals a vote of confidence from corporations on their financial health even as a recession looms large.

In this Markets in a Minute from New York Life Investments, we chart the growth of buybacks over the last two decades and the implications for investors looking ahead.

How Stock Buybacks Work

In stock buybacks, corporations buy their own shares from existing shareholders. This reduces the number of shares in the market and boosts earnings per share. Often, this can increase share prices given the rise in earnings growth.

It was not until 1982 that share repurchases became legal, driving wider usage among corporations as a capital allocation tool.

By comparison, dividends are another common form of distributing capital back to shareholders.

Dividends are bound by strict policies and do not offer the same tax advantages and flexibility as buybacks. While dividends are taxed as income, buybacks are taxed as capital gains—making them a preferential choice for investors. Given these advantages, stock buybacks have outpaced dividends over the last two decades.

In fact, in the third quarter of 2022, an estimated one in five companies in the S&P 500 Index conducted buybacks that in turn increased their earnings per share by at least 4% year-over-year.

Stock Buyback Trends

As the below table shows, stock buybacks in the S&P 500 Index outnumber dividends by about double in 2022:

Source: S&P Dow Jones Indices (Sep 2022). *For the 12-months ending June 2022.

However, stock buybacks fluctuate more often than dividends since corporations can turn them on or off. For example, in 2020, buybacks sharply declined given growing financial uncertainty. Meanwhile, companies issued dividends at a steady pace.

In this way, when share prices decline, buybacks typically decrease.

Yet unlike the last two recessions in 2008 and 2020, buybacks have shown notable strength in 2022 in spite of falling share prices.

What Are the Top Sectors for Stock Buybacks?

We can see in the table below that the biggest share repurchasers are in the tech sector, with $2.1 trillion in buybacks since 2009.

Source: Yardeni Research (Nov 2022). Represents stock buybacks for S&P 500 Index sectors.

On the other hand, utilities and other capital-intensive sectors tend to spend less on buybacks in contrast to asset-light sectors such as tech and financials.

What is also characteristic to share buybacks is their concentration. As we have seen in the second quarter this year, the top 20% of buybacks make up 47% of all repurchases across the S&P 500 Index.

New Tax On Stock Buybacks

Stock buybacks have drawn criticism for using cash to benefit shareholders instead of boosting production or improving the quality of the business.

In response, beginning in 2023, the Inflation Reduction Act puts a 1% excise tax on buybacks.

What this means is that public companies based in the U.S. must now pay a 1% tax on share repurchases, which could result in millions of additional expenses. Given this new tax rule, corporations may be accelerating buybacks ahead of year-end.

Implications for Investors

As stock buybacks have grown in prominence, it’s worth noting that not all are equal.

When a buyback aligns with a company’s long-term plan, and the company can cover their operational expenses, it can support the stability and growth of the company. When stock prices are volatile, companies can repurchase shares when they are undervalued.

By contrast, if a company takes on excess leverage in order to buyback shares, it can contribute to lower financial resilience. When a company uses a buyback to opportunistically repurchase shares, the boost in share prices may be short-lived.

In addition, it could also prevent capital from being directed to growth initiatives. In this way, it’s important to consider stock buybacks on a case-by-case basis.

With this in mind, investors can look to companies with healthy balance sheets that can weather economic storms. Here, companies that illustrate price discipline and buy back shares at a discount may help build long-term value, providing benefits to investors who stay the course.

This infographic is available as a poster.

Visualizing the Financial Conditions Index

What do financial conditions indicate about the economy? What effects do they have on growth?

From S&P 500 Index returns to the Cboe Volatility Index (VIX) to a range of credit conditions, the Chicago Fed’s Financial Conditions Index looks at whether financial activity is tighter than the historical average—or more accommodative.

This Markets in a Minute chart from New York Life Investments compares financial conditions in 2022 to the last 40 years as interest rates rise at the fastest rate in decades.

How Is the Financial Conditions Index Measured?

First, the Chicago Fed’s Financial Conditions Index takes 105 weighted average indicators of financial activity and organizes them into three main categories.

Together, the sum of these indicators provide an update on the state of U.S. financial markets.

For example, low equity market volatility is associated with lower risk and better financial conditions.

Credit market factors, such as mortgage spreads and corporate bond yield spreads, indicate the credit conditions of the economy. Credit spreads are the difference in bond yields (returns) of two different debt securities with the same maturity, but with different credit quality.

In this way, a narrower credit spread often indicates better financial conditions, while a wider credit spread indicates worse conditions. Credit spreads apply to any debt instrument like mortgages or corporate bonds.

Asset prices, as seen in the S&P 500 Index, are part of the leverage category which measures the state of U.S. debt and equity markets. When the index is declining, it can be associated with tighter conditions.

Dove vs. Hawk

Another way to look at the state of financial conditions is through a ‘dovish’ or ‘hawkish’ lens.

When conditions are more accommodative, they can be seen as more dovish. This is when monetary policy favors lower interest rates to boost economic growth and employment.

Hawkish conditions, on the other hand, are characterized by tighter monetary policy. This is seen in higher interest rates to control inflation, but typically at the expense of economic growth, spending, and employment.

The Best of Times & the Worst of Times

When have the best and worst financial conditions taken place in recent history?

Following the recession of 1990, interest rates fell after periods of unprecedented highs in the 1980s. This eased the debt burdens for corporations and households, creating some of the most favorable financial conditions in the last several decades.

Despite the early 1990s being characterized with the most accommodative conditions, the period was marked by slow economic and employment growth.

Interestingly, it was not until the second half of the decade that growth accelerated, amid low inflation and unemployment. Broadly speaking, an increase in private-sector spending and employment helped drive this growth.

By contrast, the early 1980s saw the worst financial conditions by far. Interest rates hit historic highs to rein in inflation, and financial conditions were strained.

Historically, tighter financial conditions have been linked to falling asset values and increasing risk premiums. This is the additional return an investor can expect to receive for holding a riskier asset compared to the return from a risk-free asset like a government bond.

During these conditions, economic activity can slow and the net worth of households and nonfinancial companies could decline amid tightened credit conditions.

A Closer Look: 2022 In Context

Against the backdrop of six interest rate hikes and declining equity market performance in 2022, financial markets are facing challenging conditions.

Given these factors, are conditions more hawkish or accommodative?

Compared to historical averages, financial markets still fall on the dovish side. Although conditions have slowly become less accommodative from their recent peak in mid-2021, they remain closer to neutral from a long-term perspective.

Still, corporate bond spreads, key indicators in the Financial Conditions Index, could widen if interest rates and default concerns continue to rise. Higher yields, in tandem with strain on other financial indicators like the VIX and S&P 500 returns, could tilt conditions to become more hawkish looking ahead.