Of all the signs out there that the US will manage to dodge a recession once deemed inevitable, perhaps none is more convincing than this: CEOs across the country are opting to reinvest more of their profits in expansion projects rather than handing the money back to shareholders.
The shift in cash allocation has been a hallmark of the second-quarter earnings season. With tightening credit muting share repurchases, and the siren song of artificial intelligence blaring everywhere, outlays for investment in plants and technology have blossomed. The median company pushed up capital expenditures by 15% in the period, with three-quarters announcing programs that topped analyst estimates in July, data from Bank of America Corp. shows.
By contrast, buybacks among corporate clients have been tracking below seasonal trends since May. More broadly, net repurchases plunged 36% from a year ago among S&P 500 firms that announced financial results. And the reluctance is also on display via planned buybacks, which according to Birinyi Associates have fallen 15% year—to—date.
It’s long been a goal of progressive politicians and industrial reformers: rid chief executives of their share-repurchase addictions and get them to spend on the future. Amid mounting pressure to modernize, there are signs that are happening. Goldman Sachs Group Inc. strategists forecast S&P 500 buybacks will trail capital expenditures this year for the first time since 2020.
“Corporate America is reinvesting,” BofA strategists including Ohsung Kwon and Savita Subramanian wrote in a note Monday. “The reinvestment cycle will ultimately lead to increased productivity, which will be the main driver of earnings growth going forward, vs. the last decade’s financially-engineered growth.”
The pullback in corporate demand may not go down as well with equity bulls, at least in the short term, since it weakens a big source of buying power at a time when the market’s momentum is waning. Buffeted by rising bond yields, the S&P 500 is down almost 2% over the last two sessions, the biggest drop since May.
The emphasis on capital investing, if it persists, would mark a drastic shift from the era following the 2008 financial crisis, a period when cheap money fueled debt-funded buybacks and a stagnant economy made new projects look unattractive.
Over that stretch, for every dollar generated through operation or borrowed, companies spent only 38 cents on capex, down from 54 cents prior to the financial crisis. At the same time, the money allotted to buybacks increased to 24 cents from 13 cents, according to BofA data.
Corporate America’s growing addiction to their own stock has drawn criticism from politicians and academics who say the cash would be better used on things that aim at boosting long-term growth, such as equipment upgrades or employee benefits. To deter buybacks, Congress started imposing a 1% tax this year.
To Chad Morganlander, senior portfolio manager at Washington Crossing Advisors, the latest pickup in investments is being underpinned by a slew of factors, ranging from the AI boom to President Joe Biden’s plans to boost infrastructure and clean energy.
“From a historical perspective, typically at one point when business investment rolls over, that’s the start of a recession,” he said. “Corporate investment has been historically high right now.”
To be sure, there’s no guarantee the uptick persists, particularly with the country’s economic future uncertain. Bloomberg Intelligence strategist Gina Martin Adams sees reason to believe the rate of growth in capex will decrease as the year moves on and says a lot of the spending to date has been concentrated in the tech sector.
“Unless spending related to artificial intelligence fuels a rebound, waning revenue gains likely imply weak capex growth for the balance of the year,” she wrote in a recent note.
At Goldman, strategists including Ryan Hammond and David Kostin have a more sanguine view, predicting S&P 500 firms will set aside more than $900 billion on capital spending this year and next, both ahead of the amount reserved for buybacks.
The willingness to bet more on the future is at least consistent with the appetites of investors convinced AI represents a game-changing boom in corporate efficiency. Despite three-quarters of falling profits, the S&P 500 has rallied as much as 28% from its October low, coming within striking distance from a full recovery out of 2022’s bear market.
With the S&P 500 trading at 20 times earnings, a multiple that was rarely exceeded in the past three decades, it’s understandable why some companies are reconsidering the love affair with their own stock.
In the first seven months of this year, US firms announced roughly $700 billion of buybacks, down 15% from the same period a year ago, according to data compiled by Birinyi Associates.
Not that buybacks are likely to go out of style any time soon. The drop in repurchases was mostly driven by smaller firms and followed a record year of a buying spree. Large companies in the S&P 500, according to Birinyi, have only seen a 4% cut and are still armed with a total of $1.2 trillion in unused authorizations.
“What really matters is how much companies have left to buy of their programs,” said Jeff Rubin, director of research at Birinyi. “I am not concerned that there has been a slight decline in announcements this year, especially given that the decline is off of a very substantial 2022 level.”
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