The Biggest Buyers of American Stocks Are on the Sidelines Right Now

There are plenty of potential catalysts for the stock market sell-off that has swept through the markets this week. They include rising interest rates, growing tensions with China, expanding federal deficits and increasing regulatory risks for technology companies.

Another element worth considering? The biggest buyers probably are not buying.

It may seem counterintuitive, but the largest single source of demand for U.S. stocks is the U.S. companies that issue them. Companies are on track to repurchase more than $770 billion in their own stock this year, according to research from Goldman Sachs. That is more than twice the size of the next largest source of demand, exchange-traded funds, which last year bought $347 billion in shares.

But those companies are getting ready to report earnings, an event that is preceded by a regular slowdown in buyback activity. Some large market dips in the past year have coincided with these quarterly slowdowns.

Keith Parker, head of U.S. equity research at UBS Investment Research, said the market has been weaker when buybacks have slowed. “When that dries up or slows significantly, you’re having outsized market effects,” he said.

The Standard & Poor’s 500 index fell 2.1 percent on Thursday, its sixth straight day of declines. It had tumbled 3.3 percent — the worst drop in eight months — on Wednesday. The sell-off this week comes as earnings season begins in earnest this Friday, when giant banks including JPMorgan Chase, Citigroup and Wells Fargo are scheduled to report.

When companies have more cash than they believe they can use productively, they typically return it to shareholders either with cash payments — known as dividends — or by repurchasing shares in the market. Buybacks raise demand, putting upward pressure on share prices.

Such repurchases have boomed this year as the strong economy — and steep cuts in corporate tax rates — have left U.S. companies flush with profits. Companies including Apple, Cisco Systems and Amgen have returned billions in cash to shareholders by buying back shares. Apple is responsible for the largest sum, spending nearly $64 billion on buybacks in the 12 months ending in June 2018, the last period for which full data is available, according to data from S&P Dow Jones Indices.

But corporate buybacks regularly slow around the start of the earnings reporting season, because companies want to avoid any potential legal risks from buying stock before publishing their financial results.

“You shouldn’t be out there buying stock if you know good news is about to come out and the market doesn’t know it,” said Charles Elson, a professor of finance and corporate governance at the University of Delaware.

This year, periods of reduced buyback activity have, at times, been accompanied by sharp sell-offs in stock markets. Around the time when buybacks dried up in late January, according to UBS data, the S&P 500 suffered an ugly drop, falling more than 10 percent from a record high. The market stabilized alongside corporate buying in early February. Likewise, a buyback slowdown in April was accompanied by a tumble in stocks.

The stock market’s capricious behavior cannot be traced to a single factor, of course. But a slowdown in buybacks effectively removes a lot of motivated buyers from the American exchanges, which might have been a stabilizing force.

“No one else buys back share proportionately anything like the U.S.,” said Ben Laidler, global equity strategist at HSBC. “It’s sort of a uniquely U.S. phenomenon.”