Markets Risk Overvaluing Earnings Repatriation
(Bloomberg View) -- Investors are salivating over what the $2.6 trillion stashed overseas by U.S. companies will do for the economy when much of it is returned home once the code is overhauled and repatriated earnings are taxed at a low 14 percent to 14.5 percent rate. In their heads are visions of sugar plums dancing over high wages and consumer spending, and more capital spending aiding plant and equipment suppliers as that money is spent domestically. But don’t get carried away.
My firm’s analysis shows that domestic plant and equipment spending isn’t being held back by a lack of money. Far and away the biggest driver of capital spending is the level of operating rates. When they’re low, there’s plenty of excess capacity and little need for more. In October, the Federal Reserve reported the nationwide rate at 77 percent, far below the low 80 percent rates that triggered capital spending sprees in past years. Consequently, plant and equipment spending in this business recovery has been centered on cost-cutting and productivity enhancement.
Another misconception is that more capital spending leads directly to a surge in productivity. Our analysis reveals that the correlation between year-over-year changes in plant and equipment outlays and productivity changes is very low. The strongest relationship between capital outlays in a given quarter and productivity is four quarters later, but that correlation is only 15 percent.
Why is this? Adding more machines that are similar to what’s already on the factory floor doesn’t do much for increasing output per hour worked. Also, the productivity fruits of new technologies can take years or even decades to ripen. In my judgment, today’s productivity-laden new technologies such as biotech, robotics and self-driving vehicles will spawn huge productivity gains in future years, but are not yet big enough in relation to the overall economy to move the productivity needle significantly.
Sure, corporations get three-fourths of the $1.4 trillion in proposed tax cuts over the next decade. The current system is antiquated in a globalized world where the top U.S. tax rate of 35 percent is above other developed economies, which range as low as 14.5 percent for Ireland. Also, the Internal Revenue Service taxes all profits earned at home and abroad while foreign countries tax only domestic earnings, the territorial system which the House and Senate bills move toward. That will end the incentive to keep profits overseas.
Repatriation of foreign money won’t affect pretax earnings since those profits are already booked on consolidated statements. Reserves for tax liabilities may decline, however. Earnings brought home could be used for stock buybacks and dividend increases, but most of that money is already invested in the U.S. -- 95 percent, according to a Brookings study of 15 companies with the largest cash balances.
That money resides in Treasuries, U.S. agency securities, U.S. mortgage-backed debt and dollar-denominated corporate notes and bonds. Apple, with $246 billion domiciled abroad, stated in its annual report: “The Company’s cash and cash equivalents held by foreign subsidiaries is generally based in U.S. dollar-denominated holdings.” Microsoft’s annual report says that more than 90 percent of its $124 billion in deferred cash was invested in U.S. government and agency securities, corporate debt or mortgage-backed securities.
Those funds held abroad can’t be used to compensate U.S.-based employees or for capital investment without paying U.S. taxes, but if Apple wanted to do so, it easily could do just that from its U.S. cash hoard, by issuing bonds or taking out loans from banks that are only too happy to lend to a firm with such substantial assets, be they at home or abroad.
Investors may benefit from repatriated earnings via stock buybacks and high dividends. But don’t expect a high wage-led burst of consumer spending or a surge in plant and equipment outlays.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
A. Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.”
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