One of the major themes we’ve discussed this year is the overwhelming tendency for US corporates to take advantage of record low borrowing costs and voracious demand from yield-starved investors by tapping credit markets and investing the proceeds in share repurchases. Setting aside the fact that this dynamic is embedding an enormous amount of risk in corporate credit (a booming primary market is a dangerous thing when the secondary market is completely illiquid and investors are staring down a Fed rate hike cycle), record issuance and buybacks have come at the expense of capex.
Price insensitive corporate management teams are leveraging their balance sheets in order to buyback shares, thereby artificially inflating the bottom line, boosting equity-linked compensation, and underwriting a stock market rally.
This comes at the expense of capex (i.e. investing the proceeds from debt sales in future growth and productivity). While some will note that capex hit a record in absolute terms in 2014, that obscures the fact that if one looks at how companies are using cash, the trend is clearly towards buybacks and dividends and away from investment.
This, we’ve argued, could imperil top line growth going forward, as financial engineering is not, in the final estimation, a viable growth strategy.
Against this backdrop, BofAML is out with a new note, calling business capex “a major drag” on the ‘recovery.’ Here’s more:
Business investment has been one of the more important weak links to the sluggish recoveries in most advanced economies in the aftermath of the Great Recession of 2009.
In the United States, it took 18 quarters (4.5 years) before fixed business investment regained its pre-recession peak, in chain-volume terms. That compares with an average of just five quarters before business investment recovered to its peak level prior to the onset of previous post-War recessions; previously, it had never taken longer than three years for that milestone to be attained.
Since the Great Recession, US business investment has grown at an average annual rate of 4.9%, compared with the 8.1% average for the corresponding period of all post-war recoveries. This shortfall is a much larger than the 1.8pp shortfall for household consumption, and the 2.0 pp for residential investment.
Why the weakness? As we have observed on many different occasions, banking and real estate crises tend to cause big recessions and abnormally slow recoveries. Rather than counter the balance sheet consolidation of the private sector, governments have pursued their own consolidation. It is hardly surprising that businesses lack confidence in any sustained upswing in demand that would justify taking the risks associated with large increases in investment. For many listed companies, returning surplus cash to shareholders through dividends or share buybacks has seemed a safer strategy.
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In other words, it has taken three-and-a-half times longer for capex to recover from the recession versus the historical average. Worse, it has never taken longer than three years — it took four-and-a-half years this time around. This is directly attributable to companies opting for buybacks over fixed investment, which means two things: 1) the stock market rally is illusory, and 2) corporate America's productive capacity has not grown with its market cap.