The Financing Gap That May Finally Slow Down U.S. Share Buybacksby
Companies spending more than they make could cut into buybacks
Widening credit spreads will also hinder repurchasing
American companies are sending more money out the door for things like plant upgrades and dividends than they have in the bank. A casualty of the deficit, says one research firm, could be one of the stock market’s biggest support structures: share buybacks.
Data compiled by the Federal Reserve comparing corporate capital outlays with savings and cash-flow rates shows the biggest spending deficit since the bull market began, according to the central bank’s quarterly report on U.S. financial accounts. To Neil Azous, the founder of Rareview Macro LLC, the gap is reason for concern about future share repurchases, which might be the first casualty if companies reduce spending.
“Now that we’re in year four of this buyback exercise, the hens are coming home to roost,” Azous said in a phone interview. “As companies become more leveraged, they can’t keep the same pace with buybacks. You don’t have the assumption that buyback activity will have the same tailwinds as fourth-quarter periods in the past.”
With the six-year-old rally in stocks taking its biggest hit since 2011 in the last two months, buybacks have gone from being a bull market luxury to practically the only thing left going for it. While plans for new repurchases are headed for among the biggest years since the financial crisis, any sign the buybacks could peter out would be unwelcome news for investors sitting on their biggest annual losses since 2008.
The Fed statistic, known as the financing gap, encompasses all non-financial U.S. corporations and compares their overall savings plus cash flow with their capital spending. In the second quarter, the most recent for which data is available, outlays exceeded internal funds by $238 billion, the biggest deficit since 2008, according to the Fed report.
The gap is a little-used but important indicator for investors looking to paint a picture of corporate health, according to Matt Lloyd, chief investment strategist at Advisors Asset Management in Monument, Colorado. While the measurement can indicate how likely companies are to rein in expenses, it’s a volatile figure whose quarterly values are frequently revised, he said.
“I don’t look at it as a timely indicator but it does tell me we’re in a realm in which we should be a bit more cautious,” Lloyd said in a phone interview. “The impact on buybacks is that you should see fewer.”
The influence of corporate buybacks on share performance has already shown signs of waning. Since March 13, an S&P 500 index of companies repurchasing the most shares has lost 7 percent, compared with a 2.3 percent loss in the equal-weight index of S&P 500 members. And while a surge in weekly repurchases in August helped limit losses as the S&P 500 corrected, the buying power of companies alone wasn’t sufficient to prevent the selloff.
That doesn’t mean the strategy has ground to a halt, with companies possibly turning to repurchases to help boost per-share results in the final quarter of the year, according to an Oct. 8 report by JPMorgan Chase & Co. Companies have announced $478 billion of buybacks this year and are on pace for a near record of $650 billion, the firm said.
“There’s definitely a commitment here, and unless there’s an extreme stress point in the market, companies aren’t going to reduce the price support buybacks are giving them,” Howard Silverblatt, an index analyst at New York-based S&P Dow Jones Indices, said by phone.
Investors, meanwhile, have not rewarded the strategy for three straight months, according to data from Barclays Plc. That’s the first time that’s happened since 2010, the firm said, with companies that spend more on capex being rewarded instead.
At the same time, it’s become more expensive for even the most creditworthy companies to borrow or refinance, hindering access to a key component of funding for repurchases in recent years.
“Buybacks don’t seem to work anymore,” Jonathan Glionna, head of U.S. equity strategy at Barclays, wrote in an Oct. 2 note to clients. “We do not expect the buyback factor to rebound in the near term, especially with pressure on financing costs.”