There has been a lot of debate recently about whether today’s buyback boom — a record $133 billion in buybacks for S&P companies were announced in April — is good or bad for the economy and for markets.
While some defend the buyback practice as a method of returning cash to shareholders, others, including my colleague Larry Fink, have argued that some companies today are focusing on maximizing short-term shareholder value at the expense of investing in the future.
In my opinion, today’s boom is just one economic distortion created by the Federal Reserve (Fed)’s excessively accommodative monetary policy.
The boom is, in essence, a response to today’s extraordinarily low interest rates, which have translated into abundant liquidity for corporations seeking to borrow cheaply in the capital markets.
While investment-grade corporate debt-to-equity levels are admittedly lower today than they were in the early 1990s, this metric has increased from 72% in 2010 to 85% today, and it’s likely headed higher. If we were to exclude the less leveraged information technology sector, it would already appear considerably higher, and by ratings bucket, nearly all investment-grade segments have been participating in this borrowing binge.
Indeed, the supply of dollar bond issuance in this year’s first quarter hit record levels, and those levels don’t account for the increased use of “reverse Yankee issuance,” whereby U.S. corporations issue into European markets denominated in euros.
In the early stages of this recovery, many corporations sensibly used access to inexpensive debt to term-out existing debt and to raise cash cushions on their balance sheets, an understandable response to the financial crisis and subsequent recession. In recent years, however, we have increasingly seen debt used for stock buybacks and dividends, as the chart below shows, in essence rewarding equity-holders at the (possible) expense of bondholders.
Sources: Bloomberg Finance LP, Factset, Deutsche Bank