Investors seem to have limited faith in stocks and companies underlying them. For the most part, S&P 500 companies’ Q3 earnings have been coming in ahead of expectations. And while stocks surged from its October low, they’re still down around 1% since the beginning of the year.
Robert Buckland, Citigroup’s global equity strategist, has dubbed this phenomenon a “strange situation.” “Earnings and cashflows are still growing at double digit rates, corporate balance sheets look strong but capex remains weak,” he said. “Equity valuations seem low as investors are cautious about the outlook.”
However, Buckland notes that companies are taking advantage of low valuations by de-equitizing: they’re buying back shares, issuing dividends, and engaging in M&A.
And there are two key takeaways from this:
1) Corporate stock buybacks are propping up the markets.
“US investors have sold more than $80bn worth of US equity funds this year. At the same time, US companies have bought back $200bn worth of stock. We believe corporate demand limited the downside in stock markets in August and September.”
2) They’re leveraging their buybacks by tapping the cheap credit markets, thus earning a spread.
“The unusual situation provides a unique opportunity for companies to de-equities, using cash to buy cheap equity or pay big dividends. Indeed, while US investors have been selling equities this year, US companies have been buying (Figure 2). The financial logic for companies to retire equity and de-equitise is clear – the cost of equity is unusually high, while the cost of debt or cash is unusually low. By selling debt and buying equity, companies are picking up a 250 basis point carry (Figure 3).”