Buybacks And Such

One consequence of the improved mood across risk assets was a resurgence in equity offerings.

Although IPO activity will be moribund until markets recover the kind of speculative joie de vivre that turns everyone with a brokerage account into potential exit liquidity for unicorn backers, secondaries picked up earlier this month, when issuers raised the most since the S&P was perched at record highs in early January.

July was lamentable for IPOs. Just a handful of listings raised a paltry sum that counted among the poorest showings in a half-dozen years, but the door is open again for secondaries. And corporates took advantage in early August.

Notwithstanding the nascent rebound in equity capital markets (and a concurrent pickup in primary market activity for corporate debt) 2022’s macro challenges and associated volatility created a poor environment for would-be issuers. According to JPMorgan’s Nikolaos Panigirtzoglou, the relative dearth of equity supply set against buybacks and LBOs, translated to the largest quarterly net equity withdrawal on record. That dynamic, Panigirtzoglou suggested, may have helped prevent an even larger selloff in global shares over the first half of the year.

It’s worth asking how the buyback excise tax included in Democrats’ “Inflation Reduction Act” (which, I should note, isn’t expected to have a meaningful impact on inflation one way or the other), might factor into this equation.

Generally speaking, corporates are the largest source of US equity demand, and in theory anyway, taxing buybacks is a way to compel management to invest in their businesses and workers rather than funneling cash back to shareholders by engineering higher stock prices.

“Rather than investing in their workers, mega-corporations used the windfall from Republicans’ 2017 tax cuts to juice their stock prices and reward their wealthiest investors and their executives through massive stock buybacks,” Senate Finance Committee Chair Ron Wyden said earlier this month. “Even as millions of families struggled through the pandemic, corporate stock buybacks once again hit all-time highs,” he added, suggesting the new legislation will end preferential tax code treatment for repurchases, “thereby encourag[ing] mega-corporations to invest in their workers.”

Of course, it’s not that simple. For one thing, “their workers” are getting more expensive all the time, so even if you could discourage corporates from returning cash to shareholders and somehow force them to plow it back into the business, they’d likely invest in ways to optimize productivity, automate or otherwise bolster margins in the face of elevated input costs. Suffice to say it wouldn’t be an Oprah-style “You get a raise! And you get a raise! And you get a raise!” scenario, especially not at a time when labor market realities are driving the cost of labor ever higher anyway. But more to the point, capex is a function of return on investment. The projected ROI has to be high enough to sway management. If it’s not, they’ll find another use for cash, or they’ll just sit on it.

Like most legislation that comes out of Washington, the excise tax isn’t likely to move any needles. What it may do, though, is bring forward some of next year’s projected buybacks into 2022, which could, in turn, perpetuate the supply-demand imbalance flagged by JPMorgan’s Panigirtzoglou as a support pillar for equities.

“We expect the buyback excise tax to have a limited impact on S&P 500 use of cash, but its passage creates modest downside risk to our $1.1 trillion 2023 buyback forecast and modest upside risk to buybacks in the remainder of 2022,” Goldman’s David Kostin said, noting that excluding financials, S&P 500 companies have almost $2 trillion in cash on their balance sheets. That’s a lot. Specifically, it’s 11% of assets, which Kostin said ranks 72%ile going back almost four decades.

With stock prices still well off records (even after the rally from June’s bear market lows), the looming excise tax could prompt management to front-load buybacks. For what it’s worth, authorizations come to more than $850 billion YTD, according to Goldman’s buyback desk, up 18% from the same period last year.

That said, Kostin emphasized that based on second quarter results from companies which together accounted for 90% of aggregate buybacks in 2021, realized repurchases in Q2 grew just 6% versus the same period a year ago. The figures (above) are a helpful snapshot.

To be sure, capex plans are stable currently, but given the indeterminate outlook for the economy, it isn’t especially likely that companies will ramp up spending for growth. That, in turn, suggests any decline in buyback spending may be “re-allocated to M&A or dividends,” Kostin said.

It’s worth noting that Goldman’s projections for dividend growth differ markedly from futures pricing, which implies S&P 500 dividends per share falling 5% next year and 3% in 2024. Goldman’s top-down forecasts, by contrast, suggest dividends will grow 9% in 2023 and 7% the year after.

As Kostin wrote, the median decline for S&P 500 dividends in a dozen post-War recessions is just 1%. Only once did dividends fall more than the current futures-implied two-year drop: The financial crisis.