Corporate buybacks keep market airborne

The stock market has surged lately and a lot of analysts credit it to stock buybacks by corporations. As the chart here shows, buybacks have reached dizzying heights. Corporations are purchasing their own stocks because corporate profits hit record levels last year and management can find no better use for the cash than to give it back to the owners through larger dividends or buybacks.

As I wrote recently, record corporate profits, the current level of optimism and the low yields on debt justify the current loftiness of the market. This is not a bubble, but most investors are wondering what will shoot down this high flying market? Corporations appear to be the last buyers standing because “mutual fund managers have the lowest cash levels in history and money market fund levels are lower now than in 2007 and near a record low from 2000 relative to the capitalization of the stock market."

Earnings stumble

Despite what mainstream finance and economics teach, the stock market is rational. Two things drive it - profits and risk tolerance, or as they say in finance, the discount rate. Both have advanced the stock market from its lows at the bottom of the latest recession to recent record highs as profit rates and risk tolerance soared so that investors have been willing to pay more for the same profits.

As of the writing of this post, the S&P 500 is down about 3% from its record set on March 2. Some of the selling could have come from profit taking or covering shorts, but much of it is due to concerns about future earnings. Last week I showed that profit rates are at record highs and reasonable investors would assume such rates are unsustainable based on the history. And that seems to be the case as Seeking Alpha's Brian Gilmartin wrote:

Looking at the first half of 2015, analysts are now projecting year-over-year declines in both earnings and revenues for both Q1 and Q2 '15, compared to expectations for earnings and revenue growth for both quarters back on December 31 '14.