It is interesting to note how the SPX moves in tandem with the BUYBACK Index. Investors have raised concerns that the recent tax cut is incentivizing corporations to promote more share buybacks rather than investing in R&D, Human Capital or CapEx. Some economists believe this is healthy, where firms are recirculating money back to the public by repurchasing shares at aggressive prices and thus improving shareholder returns. Other believe that this was not the intention of the tax bill, and it is merely redistributing wealth among the upper-middle class invested in the market, rather than expanding operations, driving down unemployment, and benefitting the whole population rather than wealthy individuals.
So the real question is: Are firms justified in repurchasing shares?
Well, yes, if you look closely at the current economic environment.
Fed Chairman Jerome Powell has been hawkish, similar to his predecessors Ben Bernanke and Janet Yellen, on ensuring further gradual rate increases to combat the effects of inflation. Rising rates increase the cost of borrowing for individuals, thereby promoting savings rather than capital expenditures. Analysts project a minimum of three and possibly four rate hikes this year, and as a result, firms do not find taking debt and paying high-interest attractive.
Secondly, the uncertainty of the future is a source of fear for corporations. There is no way to possibly know how technological advancements may proceed in the coming years, what travel will look like, cellular communication, energy, global warming, etc. There is so much to be addressed that corporations, who have no clue what’s in store, are simply sitting on their hands and saying, “what?”
There is a huge risk in investing in costly R&D and capital expenditures if the payoffs in the future will not cover the costs today. This is harmful to firms and shareholders and has adverse effects on companies looking to maximize shareholder value in the current and long-term.
However, firms do not have long to sit around. U.S Household net worth has achieved a 55% return on a real basis in 2017 and has strong momentum to push higher. As more households push money into investments, they expect businesses to innovate, grow, and appreciate in value. Their benefit should either come in the form of a dividend (which should come from tax cuts) or capital appreciation in share price.
But it is worth mentioning that investors do not invest in stock prices; stock prices are for speculators. Investors give their money in hopes of a business growing and adding value to the economy. It is a pledge of capital for future overall gain, not simply an increase in percentage points. Firms must consider this.
So, firms aren’t entirely wrong, but rather, are probably in fear of what’s yet to come. This month will be huge for the credit markets and the effect on the equity markets.