The end of easy money is putting another key driver of stock market gains at risk
- The prospect of interest rates staying high has weighed on corporate stock buybacks.
- Bank of America said US stock repurchases have dipped 3% in the third quarter, after a 26% drop the prior quarter.
The Federal Reserve's aggressive rate-hiking campaign that began in early 2022 marks the end of the over decade-long era of easy money, and companies no longer flush with cheap debt are pulling back on another driver of gains as a result.
In a recent note, Bank of America strategists cautioned that corporate stock buybacks in particular appear to face pressure in the new higher-for-longer interest rate regime — and that could ultimately drag on equity gains.
"We believe buybacks are more at risk from tighter credit conditions and increased cost of capital than capex," strategists led by Savita Subramanian and Ohsung Kwon said in a recent note.
The team noted how buybacks soared after the Great Financial Crisis, with companies taking advantage of cheap financing costs to repurchase their own shares.
Despite a strong start to the year, stocks have struggled in the second half of 2023. A slowdown in corporate buybacks, as Bank of America predicts, could further limit equity returns, and many firms are already telling clients to favor bonds over stocks. UBS said last week it expects 10-year Treasurys to outperform the S&P 500 at the start of next year.
Buybacks have since seen a significant slowdown, tumbling 26% year-over-year in the second quarter.
So far in the third quarter, buybacks are down 3% compared to the same time last year for 47 companies.
"Muted debt issuance suggests buybacks are likely to remain tepid going forward," strategists said, pointing to the greater difficulty companies face now in raising debt amid higher interest rates.
S&P 500 companies spent a record $922.7 billion buying back their own stock in 2022, S&P Dow Jones Indices data shows, with $211.2 billion of that coming in the final quarter of the year. That marked a new annual record, up 4.6% compared to 2021.
"The spread between earnings yield and corporate bond yield has been a strong leading indicator of buybacks, which points to muted buybacks going forward," Bank of America's strategists maintained.
There's little sign that policymakers will start cutting interest rates soon, as inflation remains above their 2% target. Joseph Kalish, the chief global macro strategist at Ned Davis Research, said any resurgence in rising prices could upend the Fed's current tightening cycle and disrupt stock and bond markets.
"A breakout in inflation expectations has traditionally caused an increase in the term premium, which would put further upward pressure on nominal yields," Kalish said Tuesday.