The Achilles Heal of the Bull Market

The risk to stocks is not the initial rate hike, nor the second or even the third. It is the point at which an increase in rates triggers a change in the economy, credit markets, or bullish psychology. 

Second, rate-hiking campaigns have consistently resulted in unfavorable outcomes. 

Additionally, the adverse effect occurred at consistently lower levels. 

When it comes to the Fed tapering, the use of buybacks to artificially boost profitability is the outlier factor. 

There is a point at which low interest rates function as a deterrent to economic activity. Due to the low return environment, businesses become unwilling to ‘invest.’ 

The issue for businesses operating in a depressed economic environment is a lack of top-line revenue growth. 

Given that higher stock prices compensate corporate executives, it’s unsurprising that firms choose buybacks over investment. 

The spike in share repurchases over the previous decade has remained one of the most important pillars of support for financial markets. 

The market impact of buybacks over the last decade. Returns on the S&P 500 are decomposed as follows: 

21% from multiple expansion, 31.4 % from earnings, 7.1 % from dividends, and 40.5 % from share repurchases. 

In other words, absent share repurchases, the stock market would be closer to 2800 than to record highs of 4700. 

With the Federal Reserve on track to begin tightening policy in 2022, there is a substantial danger that buybacks may stall. 

This was the case when many of these repurchases were financed through the issuing of cheap debt. 

Numerous tailwinds that had prevailed since March 2020 have suddenly shifted to headwinds. 

Companies who engaged in buybacks will face financial losses, more debt, and less growth opportunities in the future. 

The greatest risk to investors betting on increased stock prices is not the Federal Reserve. Rather than that, it is the cessation of stock buybacks.