Tight credit conditions weigh on share buybacks, stocks in trouble? – Stock Market News
May 25, 2023 2:27 pm
During the last few years, corporate share buybacks have been one of the main factors behind the prolonged rally observed in the equity space. However, as the period of loose credit conditions and extremely low interest rates has officially come to an end, it remains to be seen whether this theme belongs to the past. Up until now, share buybacks are holding close to their 2022 levels, supporting equity markets, but can the resiliency extend in the upcoming months?
Banking turmoil limits access to funding
This year started with the best possible omens for banks as they were expected to continue to capitalise on higher net interest margins, while the global economy showed remarkable resilience, shrugging off recession fears. Nevertheless, the mood changed drastically in March, with the implosion of three US regional banks mainly due to significant deposit outflows.
Undoubtedly, the substantially high interest rates coupled with a slowing global economy have resulted in more and more borrowers falling behind on their obligations, leaving banks with no other choices other than to keep raising provisions and tighten lending standards. When banks pull back on lending, cash reserves shrink for corporations, limiting their ability to keep buying back their own shares.
No more dry powder
Corporations have adopted share buybacks for a handful of reasons, but the macroeconomic environment was what allowed them to occur in such magnitude. Tech giants experienced significant profitability due to the extremely accommodative monetary and fiscal conditions during the pandemic, while lately energy giants capitalised on the war-induced energy crisis to ramp up their profits. Having no other attractive alternatives, these firms used huge amounts of cash to purchase their own shares, which was a strategy that many shareholders cheered.
Firstly, with buybacks firms signal that their stock is undervalued, thus investor demand rises. Moreover, retiring shares via repurchases reduces the number of stocks in circulation, bolstering profitability and performance metrics such as the widely known earnings-per-share ratio. Finally, share buybacks, unlike dividends, are not taxed until the share is sold and capital gains are realised.
However, it is highly unlikely that corporations can continue those huge repurchase programs in the upcoming future. The deadly combination of high interest rates, tight lending conditions, almost stagnant earnings and an imminent recession is likely to hit the pause button on share buybacks as companies would mostly use cash reserves to fund their investments. Does this pose a downside risk for equity indices? Probably yes, but until now their performance defies this theory.
Criticism on buybacks
Companies and investors might endorse stock buybacks, but the US government is trying to push corporations towards reinvesting their gains. The US President Joe Biden proposed a 4% tax on buybacks, which is currently at 1%, in his State of the Union address. Is this an additional reason why share repurchases could shrink in 2023?
Apart from that, it could be argued that buybacks manipulate share prices and contribute to excessive compensation of executives at the expense of growth and profitability. Hence, during this turbulent period and amid the debt-ceiling crisis, shareholders may push management towards a more efficient use of reserves. Even companies that pay dividends could gain some popularity in this uncertain environment because in contrast to share buybacks, dividends are set in stone.
S&P 500 key technical levels
In the absence of any optimistic developments regarding the debt-ceiling negotiations, the US 500 jumped to a fresh nine-month peak of 4,214. Even though Fed Chair Jerome Powell made some dovish statements regarding a potential pause from the next meeting onwards, the 2023 rally looks unsustainable without any rate cuts in 2023. So, let’s examine some key levels for traders to have in mind.
To the upside, the nine-month high of $4,214 could be the first obstacle for the bulls to clear before attacking the August peak of $4,325.
Alternatively, should the recent pullback extend, the double-bottom region of $4,050 could come under examination. Even lower, the spotlight could turn to the March low of $3,810.
During the last few years, corporate share buybacks have been one of the main factors behind the prolonged rally observed in the equity space. However, as the period of loose credit conditions and extremely low interest rates has officially come to an end, it remains to be seen whether this theme belongs to the past. Up until now, share buybacks are holding close to their 2022 levels, supporting equity markets, but can the resiliency extend in the upcoming months?
Banking turmoil limits access to funding
This year started with the best possible omens for banks as they were expected to continue to capitalise on higher net interest margins, while the global economy showed remarkable resilience, shrugging off recession fears. Nevertheless, the mood changed drastically in March, with the implosion of three US regional banks mainly due to significant deposit outflows.
Undoubtedly, the substantially high interest rates coupled with a slowing global economy have resulted in more and more borrowers falling behind on their obligations, leaving banks with no other choices other than to keep raising provisions and tighten lending standards. When banks pull back on lending, cash reserves shrink for corporations, limiting their ability to keep buying back their own shares.
No more dry powder
Corporations have adopted share buybacks for a handful of reasons, but the macroeconomic environment was what allowed them to occur in such magnitude. Tech giants experienced significant profitability due to the extremely accommodative monetary and fiscal conditions during the pandemic, while lately energy giants capitalised on the war-induced energy crisis to ramp up their profits. Having no other attractive alternatives, these firms used huge amounts of cash to purchase their own shares, which was a strategy that many shareholders cheered.
Firstly, with buybacks firms signal that their stock is undervalued, thus investor demand rises. Moreover, retiring shares via repurchases reduces the number of stocks in circulation, bolstering profitability and performance metrics such as the widely known earnings-per-share ratio. Finally, share buybacks, unlike dividends, are not taxed until the share is sold and capital gains are realised.
However, it is highly unlikely that corporations can continue those huge repurchase programs in the upcoming future. The deadly combination of high interest rates, tight lending conditions, almost stagnant earnings and an imminent recession is likely to hit the pause button on share buybacks as companies would mostly use cash reserves to fund their investments. Does this pose a downside risk for equity indices? Probably yes, but until now their performance defies this theory.
Criticism on buybacks
Companies and investors might endorse stock buybacks, but the US government is trying to push corporations towards reinvesting their gains. The US President Joe Biden proposed a 4% tax on buybacks, which is currently at 1%, in his State of the Union address. Is this an additional reason why share repurchases could shrink in 2023?
Apart from that, it could be argued that buybacks manipulate share prices and contribute to excessive compensation of executives at the expense of growth and profitability. Hence, during this turbulent period and amid the debt-ceiling crisis, shareholders may push management towards a more efficient use of reserves. Even companies that pay dividends could gain some popularity in this uncertain environment because in contrast to share buybacks, dividends are set in stone.
S&P 500 key technical levels
In the absence of any optimistic developments regarding the debt-ceiling negotiations, the US 500 jumped to a fresh nine-month peak of 4,214. Even though Fed Chair Jerome Powell made some dovish statements regarding a potential pause from the next meeting onwards, the 2023 rally looks unsustainable without any rate cuts in 2023. So, let’s examine some key levels for traders to have in mind.
Alternatively, should the recent pullback extend, the double-bottom region of $4,050 could come under examination. Even lower, the spotlight could turn to the March low of $3,810.
Related Posts: