Ok, it’s time for an update on the corporate bid for U.S. equities as investors ponder the outlook for markets after a truly abysmal October for stocks that were sitting at fresh all-time highs a scant six weeks ago.
Anytime there’s a selloff and folks are looking for excuses to stay bullish, buybacks obviously come up and it’s not hard to understand why. The corporate bid has been the largest source of U.S. equity demand for quite some time now, and this year, the tax cuts catalyzed a veritable buyback bonanza that was at least in part responsible for keeping U.S. markets insulated from global turmoil.
Over the course of the year, JPMorgan’s Nikolaos Panigirtzoglou has been keen on tracking the extent to which repatriated cash is being deployed.
JPMorgan uses the line item “foreign earnings retained abroad”, found in Table F.103 in US Flow of Funds for the “Nonfinancial Corporate Business” to assess corporate cash repatriation. Back in June, the bank predicted the torrent pace of cash repatriation would likely slow in Q2 following a Q1 that likely saw some $225 billion return to U.S. shores.
In September, the latest Flow of Funds data seemingly proved the bank was correct. Here’s Panigirtzoglou, from a September note, documenting the Q2 figure and providing some context with the 2005 episode that was frequently cited last year as a blueprint for what to expect from the new tax law:
The repatriation flow appears to have slowed considerably in Q2 to $105bn, less than half of the Q1 amount. Despite the deceleration in Q2, the current repatriation episode is still bigger and faster than the previous US repatriation episode of 2005. During the repatriation episode of 2005, $134bn was repatriated by US nonfinancial companies during the last three quarters of that year based on the decline in “foreign earnings retained abroad” relative to previous four quarters. This represented around 16% of the estimated $842bn stock of offshore cash at the time which we proxy via the cumulative “foreign earnings retained abroad” flow over the 10 years preceding 2005. In Q1 this year alone we had 11% of offshore cash being repatriated. In Q2 we had an additional 5% of cash being repatriated. So the cumulative 16% repatriation of 2005 has already been reached in only two quarters this year.
As far as what that presaged for the remainder of the year, Panigirtzoglou predicted the current episode will ultimately result in 20-25% of offshore cash being repatriated, for a total of between $400-$500 billion. Considering that, as noted in the excerpted passage above, 16% has already come home, the pace will slow markedly going forward.
Of course, just because a company repatriates cash, doesn’t mean that cash is actually deployed via buybacks (or anything else for that matter). JPMorgan proxies this by simply taking a look at the 15 U.S. companies with the largest cash holdings which together account for roughly 50% of all offshore cash piles.
“We had argued before that we can get a good idea of the amount of repatriated cash that has been actually deployed by looking at the earnings reports of US companies and in particular via observing the reduction in overall cash holdings”, Panigirtzoglou writes, in his latest note, before reminding you about the common sense rationale behind the bank’s analysis:
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.
Ok, so when Panigirtzoglou analyzed the cash holdings of the above-mentioned 15 companies, he found that “the reduction during Q3 was only $6bn, [compared] to a reduction of $47bn in Q2 and a reduction of $80bn in Q1.”
Admittedly, that doesn’t include Cisco and Pfizer (who hadn’t reported their cash holdings as of Friday), but you get the point: If Panigirtzoglou’s proxy is accurate, the pace of cash deployment is decelerating rapidly.
But he doesn’t stop there. Panigirtzoglou also takes a look at the monthly trajectory of announced buybacks and as you can see from the chart below, that trajectory has slowed meaningfully.
Importantly, JPMorgan notes that “for October, you cannot blame weakness on the reporting season, as July was also a reporting month but saw the highest buyback announcements for the year.” As far as actual buybacks, Panigirtzoglou uses net share count reduction and the picture is the same – a readily observable, steady decline since July.
The bottom line is simple, at least if you agree with the methodology. “If this trend continues, the extra boost that US repatriation provided to US equity and bond markets via share buybacks and corporate bond redemptions is largely behind us”, Panigirtzoglou concludes.
In the interest of not leaving you with a wholly sour taste in your mouth, I’ll give the last word to BofAML’s Jill Carey Hall, who offered the following quick take last month, the implication of which is that if the ratio shown in that chart normalizes, stocks should still benefit from the corporate bid for a little while longer:
Repatriation tax law changes have led to an increase in equity buyback announcements from US corporates. However, amid elevated equity valuations (and a focus on other forms of cash deployment, such as capex), less than 50% of S&P 500 index buyback announcements in 2Q were executed, based on data from S&P and Bloomberg.