A Quarter of Annual Buyback Volume Has Been Yanked, Goldman Says

(Bloomberg) -- Cash-conserving companies continue to rein in buybacks.

Data compiled by Goldman Sachs Group Inc. shows that almost 50 U.S. firms have suspended existing authorizations in the past two weeks, according to a note from its strategists. The firm’s buyback desk estimates that $190 billion has been suspended by S&P 500 companies overall -- roughly 25% of of last year’s buyback total.

“Reduced cash flows and select restrictions mandated as part of the Phase 3 fiscal legislation suggest more suspensions are likely,” Goldman Sachs strategists including David Kostin wrote to clients. “Higher volatility and lower equity valuations are among the likely consequences of reduced buybacks.”

It’s not exactly impeding stocks -- so far. The S&P 500 rose more than 3% Monday, extending the best week since 2009 and bringing the benchmark’s rally from its bottom above 17%. Still, Chris Wood, global head of equity strategy at Jefferies, says he’d be amazed if there wasn’t, at minimum, a retest of the previous lows, in part because repurchases are drying up.

“The problem for the U.S. equity asset class is that it began the downturn so overvalued at a record high valuation to sales,” Wood wrote to clients last week. “The other problem is that the leveraged share buyback game has ended, which also means an end to the phony earnings growth it produced.”

Always controversial, the sight of companies spending money on their shares has become all but unpalatable at a time when the coronavirus is spurring layoffs and raising solvency risk. President Trump said two weeks ago that he disapproved when proceeds of his 2017 tax cut were spent this way. Congress’s $2 trillion stimulus bars companies receiving a government loan from repurchases until a year after it’s repaid.

The impact of buybacks on everything from share prices and per-share earnings to the fabric of society are spiritedly debated, with easy answers elusive. On one side are claims that share repurchases brought a huge chunk of gains during the bull market, juicing executive compensation in lieu of investments elsewhere.

Opponents of that view say it overstates the impact. Using cash to repurchase shares is a value-neutral exchange of assets from one set of pockets to another -- if it increases wealth, it does so through symbolic means, they say. Moreover, too few shares are bought to affect a market where $90 trillion of stock can trade in a year.

Whatever the case, it’s been a watershed moment for a tactic that—while done everywhere—has its fullest expression in American stocks, says Stephen Dover, head of equities at Franklin Templeton. Buybacks by U.S. companies represented 70% of cash returned to shareholders in the 12 months ended June 2019, according to Morgan Stanley. In Europe, where companies ladled out about $100 billion, they accounted for roughly 30%.

The S&P 500’s record of world-beating gains could be the first casualty, Dover says. “Probably going forward there will be regulation, or there will be limits to how much companies can do buybacks and pay dividends, and that will affect how much the market appreciates,” he says. “It could put the United States market on a more even playing field with overseas markets, where buybacks are less prevalent.”

Whether that’s true -- and a lot of people disagree -- has big implications should buybacks go extinct.

A major salvo in the war over repurchases came in a 2017 paper by AQR Capital Management. It found no reason to assume buybacks drove the bull market. Evidence that they result in companies investing less in their businesses is scant, and because they’re often financed by debt, repurchases didn’t use up capital, said the authors, who include billionaire hedge fund manager Cliff Asness. The paper cited academic evidence showing that the announcement of a repurchase drives the associated stock up 1% or 2% on average—not an enormous effect, and one that may be explained in part by the vote of confidence in the company’s future that a buyback signals.

“There’s so many things that go into supply and demand for stocks, and what makes stocks attractive for investors, that viewing buybacks in isolation would miss a lot of the intrinsic value,” says Ed Clissold, chief U.S. strategist at Ned Davis Research. Eliminating buybacks “would make a difference. It would decrease demand for stocks. But if companies are growing earnings and are attractively valued, then there should be plenty demand for stocks.”

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