Corporate America celebrated the first full year under the new tax law by rolling out a record-setting $1 trillion of stock buybacks.
US companies, led by Lowe’s (LOW) and AbbVie (ABBV), rewarded shareholders by unveiling $34.4 billion in buybacks last week, according to TrimTabs Investment Research. That lifted repurchase announcements above $1 trillion for the first time ever, TrimTabs said, exceeding the prior record of $781 billion set in 2015.
And the trend continued on Monday. Johnson & Johnson (JNJ), mired in a controversy over its iconic baby powder product, announced a $5 billion buyback. Boeing (BA) also ramped up its buyback program.
The buyback boom has been fueled by strong economic growth and the corporate tax overhaul that was signed into law a year ago.
“It’s no coincidence,” said David Santschi, TrimTabs’ director of liquidity research. “A lot of the buybacks are because of the tax law. Companies have more cash to pump up the stock price.”
Not only did the tax law reduce the corporate rate, but it gave a big break to companies returning foreign profits.
Companies have used a sizable chunk of that windfall to reward shareholders. Buyback announcements have spiked 64% so far this year, TrimTabs said.
Buy (back) high?
Wall Street loves buybacks because they artificially inflate earnings and backstop prices by providing a price-insensitive buyer. But critics complain that companies often launch buybacks when prices are elevated, not necessarily when they spot a bargain. That appeared to play out this year, which started with stocks racing to all-time highs.
US companies announced $113 billion of buybacks per month during the first half of the year. But the pace of buybacks decelerated to $54 billion a month during the last six months of the year — even as stock prices plunged.
“Companies tend to buy high. When markets go down, buybacks go down,” said Santschi. “They are doing buybacks because they feel confident and business is good. Most companies don’t care what the stock price or valuation is.”
Consider the buyback misadventures at two storied American companies now in decline: General Electric and Sears.
Under former CEO Jeff Immelt, GE (GE) shelled out $24 billion on share repurchases in 2016 and 2017 at what turned out to be extremely high prices. Now, GE is grappling with a cash crunch that wiped out 59% of its value this year.
Sears (SHLD) has spent $6 billion buying back its own shares since 2005. The company’s stock price has plummeted 99% since peaking in 2007. Sears filed for bankruptcy in October.
Buybacks have been a hallmark of the bull market that began in March 2009. Corporate America has repurchased more than $4.3 trillion of its own stock since 2009, according to Yardeni Research.
Business spending isn’t booming
The market appears to have become more reliant on repurchases, with stocks stumbling when buybacks get turned off. To avoid tripping insider trading rules, companies typically avoid repurchasing shares during the two weeks prior to reporting earnings. So-called “blackout” periods have coincided with multiple market tailspins, including the one that began in early October.
Opponents of buybacks argue that companies would serve the economy better by sharing more profits with employees and investing in the future.
While companies spent heavily on buybacks after the tax law was enacted, investments in job-creating plants and equipment has been more mixed. One measure of business spending, real nonresidential fixed investment, climbed 11.5% in the first quarter of 2018 before sharply decelerating. That metric slowed to 2.5% in the third quarter, compared with 3.4% during the third quarter of 2017.
Florida GOP Senator Marco Rubio said on Twitter last week that the tax code shouldn’t encourage buybacks.
“When [a] corporation uses profits for stock buy back it’s deciding that returning capital to shareholders is better for business than investing in their products or workers,” Rubio said. “No surprise we have work life that is unstable & low paying.”
But others defend buybacks as a legitimate way to redistribute cash that would otherwise be trapped in bank accounts. Shareholders can then redeploy that cash into the economy and by investing in businesses.
“It’s not like the money disappears,” JPMorgan Chase Jamie Dimon told reporters earlier this month during a conference call held by the Business Roundtable. “The notion that it’s somehow only going to shareholders and CEOs is completely wrong.”
Even though buybacks slowed in the past few months, they’re expected to be a major source of demand in 2019. JPMorgan recently estimated $800 billion of buybacks next year on higher profits and further cash repatriation inspired by the tax law.
Of course, that could change if companies grow more concerned about the outlook. Fears about slowing economic growth have put the S&P 500 on track for its worst quarter since 2011.
And finance chiefs, the execs in charge of spearheading spending decisions, are getting worried. Almost half of US chief financial officers believe the United States will be in recession by the end of next year, according to a Duke University survey released last week.