Are We Tired of Losing Yet?

When the Tax Reform and Jobs Act was passed last year by Donald Trump and his Republican Congress (the bill passed without Democratic support), U.S. corporations saw a dramatic cut (from 35% to 21%) in federal taxes in one fell swoop. Some individuals in states with low or no income tax got a small tax break; those in high state tax states saw their federal taxes rise. We were promised lots of new capital investment from a corporate America that had received one of the biggest windfalls in modern history anywhere, investments that would produce new high-paying jobs and corporate growth that in turn would make that tax cut pay for itself. Any deficit would be absorbed by economic stimulus.

Guess what we got instead? A few companies paid some dividends to shareholders, but the bulk of the economic benefit, a three-quarters of trillion dollars’ worth of tax cut money, went into corporations to purchase their own shares – standard stock buybacks that companies normally apply when they think their shares are sorely undervalued. Except that even companies that did not have that undervaluation issue had too much cash and needed to place it somewhere. So they just bought their own shares. 

The federal deficit soared, pretty much by the exact amount of the aggregation of those buybacks. The tax cuts most definitely did not and would not pay for themselves. Ever. We can expect by trillions of dollars of resulting deficit increases over the next few years. What’s more, corporate capital improvements were largely ignored. Economically too small to count. What with Trump and his tariff wars, his wall-building obsession, a government shutdown and a Congress unable to work together, corporate America voted en masse to play it safe; it was not time for corporate expansion they figured. Buybacks!

To pay for the rich-folks-get-more deficit, Republicans were about to slash and burn “entitlements” – Social Security/Medicare (I thought people paid for those benefits; they’re not gifts), Medicaid, SNAP (food stamps), the Affordable Care Act, etc. – when they were voted out of the House of Representatives (where appropriations bills must originate), surrendering majority control to a flood of incoming angry Democrats. 

But what’s with buybacks? Obviously, the notion of share buybacks must be anchored in economic theories that benefit companies and their shareholders. Right? Effectively, where a company buys its own shares on the open market, the value of shares still owned by remaining shareholders must rise in direct proportion to the aggregate value of that buyback at least, right? Surprise, surprise. Not exactly. If the company is truly undervalued, I guess it might work, but do managers correctly believe that markets just do not reflect their worth? Especially when those buybacks occur during an overheated stock market, like the one that followed the tax cut. When shares are overpriced? Uh-huh. But buybacks always worked in the past, right? Not so much recently, it seems.

Berkshire Hathaway’s Warren Buffet thinks that such buybacks are a bad use of corporate cash. “[He] has argued that buybacks in certain cases can be a bad investment that hurts a stock’s value. If, for instance, a company buys its own shares for more than they are worth with its own cash, then it is wasting shareholders’ money. The overall value of the company should go down, though it doesn’t always work that way.

“One reason for the reversal in performance could be volume. In the last few years, the number of companies buying back stock has perhaps grown too large. That seems most likely last year, when the companies in the S&P 500 spent $770 billion on buybacks, or about three times the $286 billion they spent in 2012… With so much being spent on buybacks, it’s a decent bet that some good money is chasing bad.” Stephen Gandel writing for the February 17^th Los Angeles Times. 

Why not invest in growth? Why just buy into what you already have? “Bloomberg Intelligence compared the stock performance of companies that have devoted more of their earnings to share buybacks with those that use their profits to invest in their businesses through increased capital expenditures… The surprise was that even as buybacks have surged in the last few years, companies that have done the most repurchases have generally performed worse than those that have increased capital spending.

“A reversal appears to have happened in 2017. Before then, the stock repurchasers did better. But in 2017 and last year, the capital expenditures group was up 25%, as measured by the Nasdaq US CapEx Achievers index, compared with a rise of just 13% for the S&P 500 Buyback index. And only the group of capital expenditure companies performed better than the average company in the market. The S&P 500 index was up nearly 17% in the same time… It’s not clear why that shift occurred. Investors have long rewarded companies that buy back stock and have often been cautious about companies that spend a lot on capital expenditures.

“It’s probably because of the nature of the bets. Share buybacks are immediate and a sure thing. They reduce the number of shares and in theory make the remaining ones more valuable. Reinvesting in business is less of a sure bet. That new plant or product line or equipment might turn out to be a good investment, but perhaps not, and either way it will take time… That doesn’t mean that capital expenditures are a worse use of cash, just less certain.” LA Times. You can bet that Wall Street traders love buybacks. Any flow of buying and selling shares puts commissions, interest from supporting loans, and advisory fee money into their pockets. Capital improvements? Nope! Traders get nothing. Guess what the big financial institutions told their corporate clients to do? Yup! That!

But Wall Street was too bullish on stock buybacks. “Investors, after years of being told that buybacks only make stocks go up, have started to notice that the strategy of over-investing in those companies hasn’t been paying off. And so they have been pulling their money from investments that target buybacks. The Invesco Buyback Achievers ETF, the largest exchange-traded fund that tracks stock repurchases, has dropped to $1.1 billion in assets, down from $3 billion four years ago.” LA Times. Hmmm? 

What is equally clear is that by the end of 2018, the market had already reflected any benefits from that tax reform act and the resulting buybacks. The momentary surge in the stock market simply melted away in the aftermath of… well… nothing happening to make the economy grow. Aside from internal instability with Trump at the helm, waves of bad economic news were rippling through China, and both France and Germany felt slowdowns. The inability to resolve Brexit didn’t help either. 

By the end of 2018 the share markets had become yoyos, soaring and crashing, responding to news with unstable and dramatic moves up or down on seemingly a whim. The “R” word – recession – became the talk of the financial markets. When? How severe? Nobody was sure. Let’s see, a volatile but overheated stock market with signs of economic contraction rising every day. What could possibly go wrong?

Funny how Democrats were always wary of the benefits of a big sudden corporate tax cut – Bernie Sanders wants to limit and tax against buybacks (they are definitely not job creators!) – but there is now a rising tide of Republicans who are now railing against how corporate America wasted so much money on an investment structure with decidedly few benefits for most of us. “Sen. Marco Rubio has joined the buybacks-are-bad-for-America bandwagon, calling for a new tax that would neutralize the advantage repurchases have over dividends.” LA Times. 

It just might be that giving away gobs of money to the rich that must be repaid by the rest of us (that tax cut) just might have been the worst Republican legislation of the Trump era. And they brag about it, thinking that somehow this will help them win the 2020 election.

              I’m Peter Dekom, and I am afraid that the issues and economics behind them are so hard for most folks to understanding that they outsource their opinions to agenda-driven politicians and rely heavily on catchy-but-empty slogans instead.