If you’re looking for a relatively positive narrative to latch onto on a day when Caterpillar and Nvidia deep-sixed sentiment (in the process heightening market concerns about global growth and a decelerating Chinese economy), you can always lean on the old buybacks crutch.
As you’re hopefully aware, the corporate bid has been the largest source of demand for US equities for quite a while and according to JPMorgan’s Dubravko Lakos-Bujas, the outlook for buybacks remains robust – to say the least.
After noting that S&P corporate management teams have returned a staggering $5 trillion to shareholders since 2009 (adding roughly 2% to annual earnings growth in the process), Lakos-Bujas reminds you that “despite the recent market volatility, buyback activity has been very strong during 4Q18, including December.”
(JPMorgan)
If you ask JPMorgan (or at least if you ask Lakos-Bujas, whose opinion on this may differ from his colleague Nikolaos Panigirtzoglou), buyback activity should “remain robust in 2019 given profit growth (30% EPS growth 2017-19), lower valuation (~1x lower than average and ~4x lower than cycle peak), and a record high ~$700b available to execute under existing authorizations.”
If you’re looking for specifics, Lakos-Bujas is expecting S&P 500 companies to execute somewhere in the neighborhood of ~$800 billion in buybacks this year (see right pane in the visuals above), in addition to returning something on the order of ~$500 billion to shareholders via dividends.
A key concern in the post-crisis years has of course been the extent to which corporate management teams have resorted to financial engineering, borrowing at rock-bottom rates (thanks to the QE-inspired hunt for yield) and plowing the proceeds into EPS-inflating buybacks. On that score, Lakos-Bujas has some good news.
“Buyback executions in 2018 have been some of the highest quality of this cycle as they have been predominantly funded by cash rather than debt, a trend we expect to persist into 2019”, he writes, referencing the following visual.
(JPMorgan)
As you can see, debt-funded buybacks peaked at 34% in 2017 and have since plunged to just 14%, a cycle low. That’s thanks at least in part to the tax cuts and surging profit growth. In contrast to the above-mentioned Panigirtzoglou (who has expressed some skepticism about whether repatriation flows can continue to bolster equities via buybacks), Lakos-Bujas sees scope for “more cowbell” (so to speak).
“Corporates [will] continue repatriating foreign-held cash in 2019”, he says, adding that on his estimates, “US Corporates in aggregate have already repatriated ~$570b in foreign cash (1Q-3Q) and we expect cash repatriation to pick-up incrementally as recent IRS guidance on section 96 transition tax (treatment of foreign retained profits) is digested.”
(JPMorgan)
If you’re wondering which sectors will likely see the most activity – actually, if you’re wondering that, you shouldn’t be, because the answer is self-evident, but let’s just assume you’re in the dark – the answer is Tech and Financials, with the former incentivized by better growth prospects, better margins, lower capital requirements, and elevated overseas balances.
The read-through here is that not only will buybacks continue to provide a pillar of support, but that that pillar rests on a firm foundation (cash-funded versus debt-funded).
Obviously (i.e., mechanically) the above entails more “de-equitization” (if you will). As Lakos-Bujas goes on to note, the S&P 500 divisor… is already at a 20-year low” and because this “ongoing reduction in equity supply is largely a US theme” it may well “help explain some of the structural valuation premium for US versus other DM equities.”
Take all of that for what it’s worth. One certainly imagines there will be no shortage of skepticism when it comes to the idea that corporate management teams will eschew debt-funded buybacks going forward.
Then again, according to BofAML’s most recent Global Fund Manager survey, investors have had just about enough leverage for one cycle…
(BofAML)
