Now, there is nothing wrong with stock buybacks and dividends per se, and indeed they can contribute to a very sensible corporate capital allocation strategy, but should this use of capital crowd out long-term capital expenditure (investment) in a firm’s core business, or begin to threaten its credit quality, then it can become concerning.
And this is what we are seeing today. At an aggregate level, the percentage of U.S. corporate cash sources now used for some form of immediate shareholder benefit, such as stock buybacks or dividend payments, has recently exceeded the amount firms are spending on capex. At current interest rate levels, corporate leaders are incentivized to merely leverage firm capital stacks and avoid riskier capex that may not pay off, particularly as shareholders agitate for a return of cash.
Indeed, the global economy is witnessing a massive redistribution of wealth and income with borrowers, equity shareholders and short-term investors benefiting; and savers, bondholders and longer-term investors being placed at risk.
Looking forward, I do expect that corporate borrowing should moderate as rates gradually rise. In the end, leveraging cycles eventually turn, policy evolves, and the threat of technological and competitive disruption should combine to force companies back to investing in their productive capacity. In the meantime, as we wait for the start of rate normalization, firms continue to play capital structure arbitrage, and the cost of waiting to lift off from “emergency” interest rate levels grows.
Sources: BlackRock, Bloomberg, Factset, Deutsche Bank
Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Fundamental Fixed Income, is Co-head of Americas Fixed Income, and is a regular contributor to The Blog. You can find more of his posts here.