Goldman Sachs: Don't Count on a Repeat of the QE-Induced Buyback Bonanza in Europe

The incentives just aren't there.
Photographer: Jasper Juinen/Bloomberg

A key channel through which massive central bank asset purchases helped reflate the U.S. economy won't be as effective in Europe, according to strategists at Goldman Sachs Group Inc.

By slashing interest rates and purchasing government bonds, the Federal Reserve pushed investors into riskier asset classes such as corporate debt. This resulted in cheaper borrowing costs for U.S. companies and tighter spreads relative to U.S. Treasuries.   

Many companies used these favorable financing conditions as an opportunity to support their share prices by issuing debt to buy back their own stock—and the ensuing "wealth effect" gave consumer spending an added boost. 

But don't bet on more of the same in Europe, say strategists led by Peter Oppenheimer, Goldman's chief global equity strategist. The bank's pessimism regarding corporate buybacks stands in stark contrast to the views of other analysts, who have previously speculated that new stimulus measures unveiled by the European Central bank last month could help lower corporate borrowing costs and spark a scramble for share repurchases.

"The boom in U.S. share buybacks has left many investors expecting a similar trend in Europe, or questioning whether one might emerge," Goldman's Oppenheimer writes in a note to clients. "We doubt it."

Goldman's reasoning is simple: Outside of the England, European executives don't have as much of an incentive to take on debt to juice earnings and returns as they do stateside.

Goldman COMP
Source: Goldman Sachs

"While CEO compensation is linked to shareholder returns in close to 70 percent of S&P companies (and FTSE 100 companies), this is the case for less than 40 percent of the Euro STOXX 50 and less than 30 percent of DAX companies," writes Oppenheimer.

Oppenheimer's dismal outlook for European buybacks comes despite a high cost of equity relative to debt, a dynamic that seems to augur well for buybacks.

According to Goldman, a lack of confidence in the outlook for the European economy means that companies continue to prefer to hoard cash rather than deploy it to shrink their outstanding share count.

"Preference for cash has increased despite record low levels of interest rates because the extraordinary stance of monetary policy is seen as a function of a very weak or uncertain path for growth and inflation," asserts Oppenheimer. "As a consequence, U.S. companies have actively been re-leveraging since the end of the Lehman [Brothers Inc.] crisis, whereas euro area companies continue to de-leverage, as they have been doing since the start of the financial crisis in 2008."

Under this prism, the outlook for buybacks is more cyclically than structurally constrained and will firm in tandem with the economic backdrop.

While Goldman is decidedly not a fan of companies buying back their own stock (Chief U.S. Equity Strategist David Kostin has previously recommended that firms should purchase other companies' stocks instead), the bank does acknowledge their importance to this bull market.  

Kostin has indicated that the bounce-back in U.S. stocks after the abysmal start to 2016 was wholly a function of the resumption of corporate share repurchasing programs.

As European equities receive less support from their corporate overlords, Oppenheimer writes that money flows from foreign investors will continue to wield an outsize influence over fluctuations in their respective stock markets.

"We do not expect to see a strong acceleration in buybacks in Europe and continue to view the market as fully valued and offering a 'fat and flat' return," the strategist concludes.

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