3 forces pushing stock prices higher

U.S. stocks have been on a roll, setting repeated new record highs for the S&P 500 and Nasdaq Composite. The Dow Jones industrials index has been the laggard, weighed down by losses in trade-sensitive names like Boeing. However, it’s still within 2 percent of its Jan. 26 peak, and it seems likely to cross that mark any day now.

Stock index futures on Thursday morning were down slightly after four straight days of gains on the major indexes, but at this point, August seems sure to be another month of rising stock prices — the fifth in a row for the S&P 500 and Nasdaq and the second for the Dow Jones industrials.

This is already the longest bull market ever, and the current U.S. economic expansion is also one of the longest in history. Yet nagging concerns remain, from the specter of political shenanigans (impeachment?) looming after Election Day to the deepening trade rift between the U.S. and China.

But equity investors apparently couldn’t care less. Here are three reasons for their enduring optimism:

Share buybacks and dividends

Corporate earnings growth has been strong. Credit has been cheap. And CEOs and other executives often have their compensation tied to things like earnings per share and share price performance. With mergers and acquisitions looking uncertain (given high prices for potential targets) and hiring/investment spending risky, many businesses have opted instead to buy back their own shares, helping boost their own stock prices and earnings-per-share measures.

Since the start of the current bull market in the first quarter of 2009, S&P 500 companies have repurchased $4.1 trillion worth of their own shares, according to Yardeni Research. Over this time, corporations paid $2.9 trillion in dividends. In 2018’s first quarter, the sum of the two was running at a $1.2 trillion annual rate — a record level — boosted by the corporate tax cuts delivered by President Donald Trump and Republicans in Congress.

Given this level of stock buybacks, the number of S&P 500 shares outstanding has fallen 3.3 percent from the middle of 2006 through the end of 2017 and is 7.7 percent lower from the post-crisis high of early 2011.

Earnings and revenues

That smaller share count is pushing S&P 500 earnings per share ever deeper into record territory. Analysts are looking earnings per share of $172.95 on a forward basis, representing year-over-year EPS growth well in excess of 20 percent.

Revenues jumped 10.3 percent over the previous year’s last quarter, also to a new record high. Yardeni Research noted that normally this far into an economic expansion, something between 4 percent and 6 percent growth is more typical.

Profit margins are also at an all-time high, with the S&P 500 corporate margins sitting at 10.9 percent vs. 10.1 percent at the end of 2017.

Skeptics still on the sidelines

One of the bigger reasons for share price gains this year has been a “short squeeze” dynamic following the nasty sell-off in February, after which many hedge funds and other professional investors took big bets that stocks would keep falling, known as short positions. But as stock prices melted higher instead, those short positions have been squeezed and then closed as investors who bet on a continued fall are forced to purchase stocks to get out of those money-losing positions.

Ironically, on days when stocks push to new records, the most hated shares by hedge fund types are leading the way. According to Goldman Sachs, a basket of 50 stocks in the Russell 3000 index with market capitalizations more of than $1 billion and the largest outstanding short interest have outperformed the S&P 500 by 14 percent so far this year.

High-flying big-cap technology stocks like Amazon, which flirted with a share price of $2,000 on Wednesday after an upgrade by Morgan Stanley analysts, sit at the center of this dynamic. Yet they just keep rising, with Amazon alone responsible for nearly a quarter of the Nasdaq’s 1,000-point climb from 7,000 to 8,000 earlier this month.

The more these stocks just refuse to decline, the more the skeptics are forced to buy in — perpetuating the cycle. 

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