It was a little over a year ago, when Trump’s then chief economic advisor, former Goldman COO Gary Cohn had an epiphany in which he realized that Trump’s entire overarching economic policy of encouraging tax repatriation so companies would invest in the US, spend on R&D and hire more workers, had been a disaster.
During an event for the Wall Street Journal’s CEO Council in November 2017, an editor at The Wall Street Journal asked the room: “If the tax reform bill goes through, do you plan to increase investment — your company’s investment, capital investment?” He asked for a show of hands.
Alas, as the camera revealed, virtually nobody raised their hand.
Responding to this “unexpected” lack of enthusiasm to invest in growth, Cohn had one question: “Why aren’t the other hands up?”
VIDEO: CEOs asked if they plan to increase their company’s capital investments if the GOP’s tax bill passes.
A few hands go up.
“Why aren’t the other hands up?” Gary Cohn asks.#WSJCEOCouncil pic.twitter.com/TD2oAlN27S— Natalie Andrews (@nataliewsj) November 14, 2017
Cohn’s confusion was understandable: this one simple experiment revealed that Cohn’s entire economic policy was a disaster, and that instead of using repatriated cash to invest, most US corporations would use the newly-unlocked funds to double down on stock buybacks. And while the former Goldman president tried to cover up his disappointment with laughter, the cognitive dissonance between the stated intention behind tax reform, and what it would ultimately achieve, or rather not achieve, was painfully obvious to everyone.
Fast forward one year, when what was only speculated had been confirmed, and not only were total corporate buybacks in 2018 set for an unprecedented record high, surpassing $1 trillion for the first time…
… but, in a slap to the Trump administration’s implicit request, buybacks would surpass CapEx spending for the second quarter in a row.
And now, confirming all of the above, in his latest Flows and Liquidity newsletter, JPMorgan’s Nikolaos Panigirtzoglou finds that while US companies brought back hundreds of billions in profits from overseas to take advantage from last year’s tax break, most of it went to share buybacks, with far less spent on debt repayment, while capital spending was a distant third.
However, in a more troubling sign for equity bulls, JPM also found that the amount of cash repatriated, and thus fund the “buyer of last resort” i.e., corporate stock repurchases, has been declining dramatically,
To calculate the amount of cash that was repatriated, the JPM strategist looked at “foreign earnings retained abroad”, disclosed in Table F.103 in US Flow of Funds for the “Nonfinancial Corporate Business”, relative to its 2017 average. This repatriation proxy declined to only $60bn in Q3 vs. $115bn in Q2 and $225bn in Q1.
This implies that just like the trade boost for much of 2018 which was the result of frontrunning higher US-China tariffs, the US repatriation flow was also effectively frontloaded in Q1 and had been almost halved in Q2 and halved again in Q3. Assuming another halving in Q4, would practically mean that the current repatriation episode would be largely completed by the
end of the year with the cumulative amount having repatriated by the US nonfinancial sector reaching around $430bn, or 20% of JPMorgan’s estimated $2.1tr stock of offshore cash.
This deceleration pattern implied by the US Flow of Funds data is also consistent with the company reports from the reporting season. In particular, JPM notes that analysts can get a good idea of the amount of repatriated cash that has been actually deployed via looking at the earnings reports of US companies and in particular via observing the reduction in overall cash holdings. When the offshore cash is repatriated but not deployed, then overall cash holdings should be unchanged as the only change that has happened is that a portion of cash has switched location from offshore to onshore. But when the repatriated cash is deployed, in order for the company to buy back shares or to fund other activities, then the overall amount of reported cash holdings should decline.
And sure enough, confirming the Flow of Funds approximation, JPMorgan looked at the overall cash holdings for the universe of the 15 US companies with the highest cash holdings: the reduction in reported cash holdings during Q3 was only $6bn, compared to $47bn in Q2 and $80bn in Q1 (Figure 2). So here too there is a rapidly decelerating trajectory similar to the pattern from the US Flow of Funds repatriation proxy.
Now that we know that US corporations repatriated far less cash in Q3 then they did in Q1 and Q2, let’s go back to the use of funds.
As noted above, JPMorgan estimates that around half or $190bn of the above $400bn has been used for increased US share buybacks. In particular, the reported “net decrease in the capital stock”, a proxy for share buybacks, increased to just below $200bn per quarter in Q1-Q3 this year vs. $134bn per quarter in 2017 for S&P500 index companies. So a net incremental change of $64bn per quarter or $190bn in total during Q1-Q3.
The second most popular use of funds was repaying debt, as another $90bn was likely used for corporate bond withdrawal, judging by the decline in domestic net issuance of US corporate bonds during the first quarters of the year.
This means that a mere $75 billion appears to have been used for capex, a far lower number than the Trump administration initially paraded to obtain broad support for its tax repatriation holiday strategy. The remaining $45bn of the $400bn Q1-Q3 repatriation flow was likely deployed in Q4 mostly as share buybacks.
Finally, a third confirmation for slowing buybacks – something we first discussed one month ago – comes from public information on announced US buybacks, which also show a decelerating pattern. The monthly trajectory for announced buybacks for S&P500 index companies is shown in the chart below.
Following an accelerating pattern during the first seven months of the year and a peak in July, the flow of announced buybacks had been very small for three months in a row between August and October, coinciding with the time rates pushed sharply higher and market turbulence first emerged. And while November was somewhat stronger than October, but far from the exuberant pace of the first seven months of the year.
In other words the picture we get from Figure 3 is that the repatriation-induced exuberance in share buyback announcements is behind us.
This is a problem because while another JPM strategist, Marko Kolanovic believes that stocks are set to surge some 18% over the next 12 months, rising to 3,100 by the end of 2019, Panigirtzoglou is not so sure, and as he writes, “if the above trends continue, the extra boost that US repatriation provided to US equity and bond markets via share buybacks and corporate bond redemptions would likely dissipate next year.”
And speaking of the Kolanovic (bullish) vs Panigirtzoglou (bearish) worldview schism, one which was on full display on Friday, when JPM’s chief quant and derivatives strategist blamed “specialized websites that mass produce a mix of real and fake news” for screwing up his optimistic forecast, which is somewhat paradoxical when considering that another member of JPM’s own team week after week published far less bullish takes than the official “house view”, here is how Panigirtzoglou defends himself against any potential future allegations by Kolanovic that he is merely spreading “fake and bad” news:
As a note to our readers, the above analysis does not represent JPM’s official views/forecasts about US share buybacks. These JPM official forecasts are more positive and are outlined in the reports by our US equity strategists (Dubravko Lakos-Bujas and team). Instead, the objective of our analysis is to highlight risks around the house view.
In other words, the objective is to explain why “those other guys” are always wrong…
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