If you’re not feeling particularly inspired about risk assets to start the week, you’ll be forgiven.
As detailed here in a number of posts over the past couple of days, the coordinated global dovish pivot from central banks is certainly welcome news for those hoping for more “manna from heaven” (to quote Credit Suisse), but policymakers’ “blink for the ages“, doesn’t do much to ameliorate the near-term headwinds to global growth and corporate profitability.
In fact, you could easily argue (and believe me, some people have) that the mere fact that central banks have seemingly thrown in the towel on the tightening push (at least for now) actually “validates” the slowdown narrative and is thus a cause for concern.
One issue is that unlike previous episodes that have necessitated central bank verbal (and actual) intervention, this time around, many of the factors that are conspiring to cloud the outlook are beyond monetary policymakers’ control. The trade war and US political gridlock, for instance, are the product of Donald Trump’s efforts to reshape global commerce and rewrite immigration policy in the image of his campaign (and do note there’s nothing at all pejorative in that assessment, that just is what he’s trying to do).
When you consider that in conjunction with concerns that monetary policy is constrained (i.e., normalization has only just begun; rates are still either near the zero bound or negative; balance sheets are still bloated) you end up with pressing questions about how much can be accomplished in terms of reflating the global economy and reinvigorating risk assets in the absence of a resolution to the geopolitical risks that are at the heart of the problem.
At the same time, corporate profit growth looks like it’s all set to decelerate meaningfully. As documented here over the weekend, an earnings recession is not out of the question with analyst estimates for Q1 having recently turned negative.
SocGen’s Andrew Lapthorne picks up on all of the above in a Monday note.
“We can understand why investors are turning more cautious, as the Fed-inspired rebound does not dispel the fact that profit growth is turning negative in what appears to be a synchronized global slowdown”, he writes, adding that “US 1Q ex-financial growth is now forecast to be negative and year-ahead forecasts are being cut quickest since 2016.”
As you might imagine if you’ve followed Lapthorne’s work over the years, he is (extremely) averse to debt-funded buybacks, especially when share prices are inflated as they’ve been for years prior to the Q4 2018 risk asset meltdown.
You can trace the “Andrew versus buybacks” story back pretty much as far as you want to go. It’s literally years in the making. Perhaps our favorite Lapthorne quote ever is his straightforward assessment of companies who issue debt at artificially suppressed borrowing costs in order to implement bottom-line-inflating buybacks at nosebleed equity valuations.
“As we have long pointed out, the reason for [the] increase in debt is largely down to financial engineering – aka share buybacks”, he wrote long ago, adding that “borrowing money to buy back your elevated shares is clearly nonsense”.
Give his express aversion to financial engineering, you might be wondering if he noticed the increase in the “quality” of buybacks catalyzed by repatriation flows. We dove into this discussion on January 28.
“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”, JPMorgan’s Dubravko Lakos-Bujas wrote last month, referencing the following visual.
That stark reversal of trend (towards cash-funded rather than debt-funded buybacks) comes courtesy of the tax overhaul which catalyzed a surge in profit growth and cash repatriation. For his part, Lakos-Bujas expects that trend to continue in the new year.
Meanwhile, the buyback story has obviously become a hot potato for US politicians, many of whom are not enamored with the idea that shareholders have disproportionately benefited from Trump’s tax policies.
Lapthorne, unsurprisingly, isn’t satisfied that everyone understands what the real problem is. To wit:
One quick comment on buybacks (of which we are not fans) which have become a political beach-ball in the US recently. We have no issue with companies returning ‘spare cash’ to investors and are also of the view that there is little relationship between corporate spending and buybacks. However, in all the articles we have read recently hardly anyone raises the debt side of the equation. It is debt-funded buybacks not buybacks per se that are the problem.
Got that, everybody?! If not, that’s fine, because you can be absolutely sure that Andrew will tell you another dozen times over the next six or so months.
To drive the point home, he includes an updated version of one of his oft-used visuals and as you can see from the header, the recent divergence (i.e., the “quality” buyback trend) is “down to repatriation” and thus perhaps not deserving of the “credit” (no pun intended), it’s getting.