Donald Trump wants to reform America’s corporate tax system and give companies a sweeter deal that encourage them to bring profits home, instead of stashing them overseas. Once some of this $2.6 trillion is back onshore, it could fuel investment and expansion and hiring and acquisitions in the United States.
But corporate America may not be interested in sharing its new tax break with the rest of the country. Instead, Goldman Sachs is predicting that the companies in the S&P 500 Index – the 500 biggest public companies in America – will spend a record amount of money on stock buybacks next year.
From the report:
In 2017, for only the second time in 20 years, repurchases will account for the largest share of cash use by S&P 500 companies.
Total capital usage will increase by 12% to $2.6 trillion with 52% allocated to investing for growth (capex, R&D, and cash M&A) and 48% to returning to shareholders.
Quick recap: in a stock buyback, companies buy their own shares from the public markets using their own cash. Buybacks serve a specific purpose: they make a company’s earnings look better without them having to actually be better. They can – though they haven’t much lately – help bolster a company’s stock price. The sacrifice here, though, is that the money spent on buybacks is not being spent on building new factories, raising wages, hiring workers or growing the business. Trump’s tax plan is to lower the overall corporate rate to 15% from 35%. It will also lower the tax rate on profits stashed overseas to 10%, which can be paid over 10 years. The repatriation could lead to a 30% surge in buybacks by the S&P 500 companies, Goldman says. Without tax reform, the increase would be closer to 5%.
In other words, a fat chunk of the money companies are going to bring home is going to go right back to people who own stocks, which is to say, not to investment in the overall economy and the people who work in it. Simply put, buybacks invest in stock prices, but not in America. To be fair, we should note that it’s not all going to buybacks. Goldman says about half will go to more productive uses – like cash acquisition, research & development, and capital expenditures. These will increase by 5% to 7%, the bank predicts. But repurchases will trump any one of these other uses in terms of size.
The other thing this tells us
In the wake of Trump's election to President of the United States the stock market has rallied to all-time highs. While some think this is a signal Trump will be great for corporate America, this rush to buybacks tells us a different story.
Buybacks are generally used as a way to invest cash when the economy is uncertain. CEOs don't want to invest in say, a new factory, if they think the economy is about to slow down. They also don't want to just sit on cash and watch inflation erode its value, so they turn to buybacks.
The fact that Goldman says companies are about to spend a ton of money that way next year tells us that they're worried about economic growth and profits.
And they have plenty of reason to worry too. Earnings have been on the decline for years, and next year's outlook isn't much better. Plus, borrowing costs are going up, not just because the Federal Reserve will likely raise interest rates, but also because markets are anticipating that Trump will throw money at a stimulus package, resulting in inflation. His tough stance on trade is also inflationary, according to analysts at Deutsche Bank.
See, one thing is giving corporate America a tax break and saying "have at it." Another thing is creating an economic environment where corporations feel secure enough to invest. Obviously the idea of a Trump presidency, though it has boosted stocks in the extremely near-term, isn't making companies feel secure into 2017.
Thanks to buybacks, though, that doesn't mean their stocks will go down substantially at the outset. It just means they won't be investing as much in the things that actually make America great - research and development, capital expenditures, and higher wages.
Listen to BI's Linette Lopez and Josh Barro talk Trump trade policy on their podcast, Hard Pass.