Ok, so part and parcel of the bull thesis for U.S. equities going forward is the assumption that the buyback tailwind (created in part by the tax cuts) will act as real-life plunge protection come hell or high tariffs.
That contention was seemingly borne out in February, when Goldman’s buyback desk had its most active two-week stretch ever.
“The Goldman Sachs Corporate Trading Desk recently completed the two most active weeks in its history and the desk’s executions have increased by almost 80% YTD vs. 2017,” the bank wrote, in a late February note published after the turmoil surrounding the VIX ETP implosion and the consequent deleveraging by the systematic crowd had largely run its course.
Fast forward four months and folks are still counting on buybacks to help support U.S. equities which, along with other risk assets, are staring down a veritable laundry list of concerns, not the least of which is the increasingly dangerous game of trade chicken between Donald Trump and the rest of the world.
Over the last several days, the trade bombast was cranked up several more notches. On Friday, Trump again threatened to tax European auto imports just two days after a guidance cut from Daimler delivered a serious blow to sentiment. Then, on Sunday evening, reports indicated that the administration is all set to announce a new plan that seeks to restrict Chinese investment in U.S. industries on national security concerns. Those would be the same national security concerns Trump is using to justify the proposed auto tariffs.
Through it all, U.S. equities have remained resilient, especially when compared to global counterparts and one of the pillars of support is the assumption that record buybacks will be there to cushion the blow whenever geopolitical risk comes calling (which is every fucking day). Goldman, for instance, cited buybacks in their relatively upbeat note raising EPS forecasts last week.
Well on Friday, JPMorgan’s Nikolaos Panigirtzoglou was out with the latest version of the bank’s popular “Flows And Liquidity” series and he’s got some interesting observations about share repurchases.
He begins by noting that the pace of repatriation looks to be well out ahead of the previous episode in 2005.
“The $217bn that was likely repatriated during the first quarter of 2018 represents around 10% of our estimated $2.1tr stock of offshore cash,” Panigirtzoglou writes, adding that “during the repatriation episode of 2005, we estimate that $132bn was repatriated by US non-financial companies during the last three quarters of that year, represent[ing] around 15% of the estimated $863bn stock of offshore cash at the time.”
So in other words, corporates have brought back 10% of offshore cash in one quarter this time around versus 15% in three quarters in 2005, thus the conclusion that the pace is much faster. Here’s a fun chart:
Ok, so next JPMorgan looks at how much of the repatriated cash was deployed. This is a pretty simple exercise. Basically they just look at reported cash holdings and note a reduction from Q4 2017 to Q1 2018 of some $81 billion.
Predictably, almost none of that $81 billion was used for capex.
“Of the $81bn of repatriation flow in Q1, $35bn was likely used for share buybacks, only $2bn for capex, and the rest ($44bn) was likely used for withdrawing corporate debt,” Panigirtzoglou says.
Next comes the good part. Panigirtzoglou goes on to explain what’s behind the relatively good returns for U.S. stocks this quarter:
We do not have earnings reports for Q2 yet, but based on the average divisor change of four US equity indices, a proxy for the share count, we estimate that the net equity withdrawal by US companies overall including both financial and non-financial companies tripled in Q2 ($150bn) vs Q1 ($50bn) as shown in Figure 3. This big acceleration of the net equity withdrawal was likely behind the outperformance of US equities during Q2. The divisor change, by capturing the change in the share count , is in our opinion a more comprehensive proxy of the net equity withdrawal than the “net decrease in the capital stock” reported by companies as it captures the combined impact of all corporate issuance activities including employee stock programs. This is one reason the two proxies are different.
So what does this mean going forward?
Well, first of all, Panigirtzoglou extrapolates a cumulative repatriation total for 2018 and uses that to calculate a full-year total for net equity withdrawal. Ultimately, he says his math ends up being consistent with the bank’s $800 billion projection for gross buybacks.
The good news is, “the extra $200bn of net equity withdrawal or reduction in the share count should overall act as a backstop for the US equity market this year”, just as it served to prop up stocks in Q2.
The bad news is two-fold. To wit:
But the exceptional strong US net equity withdrawal of $150bn for Q2 is less likely to be repeated in the second half of this year, unless an equity market correction induces US companies to step up their share buyback activity as it happened before during Q3 2015 or Q1 2016 (Figure 3).
The very strong US buyback activity and the outperformance of US equities in Q2 failed to make retail investors more bullish. If anything equity fund flows, which have been averaging less than $15bn per month since February, turned even weaker in June.
So I don’t know, I guess the fact that stocks’ recent push higher has been a tedious affair is your fault (?) for not being more bullish in Q2 by funneling money into equity funds.
And according to the above, you might have missed the best opportunity to capitalize on the buyback bonanza.
But hey, at least you can still ride the systematic re-risking bid which should play out assuming volatility stays low and momentum signals don’t roll over. And shit, there’s more than a little irony in that, because as I argued over the weekend, “to the extent passive investing helps to tamp down volatility, it could easily be argued that it indirectly forced volatility-sensitive strategies to increase leverage and led VaR models to run exposures that bump up against pre-defined risk limits.”
Chicken-egg, carts-horses – and all that.