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Companies pushing up share prices with buybacks (while their executives sell personal holdings into the flow) have greatly supported stock prices (and executive compensation) over the past decade. The party was planned to continue in 2023 with a record $360 billion in buybacks authorized year-to-date. But, as usual, something unexpected happened on easy money street: leaping borrowing costs, slower sales, and falling profits.

We’ve long observed that companies (like households) are pro-cyclical; they buy equities the most when valuations are frothy and the least when deeply discounted.

Recent Goldman Sachs data shows that executed buybacks were -20% year-over-year in the fourth quarter of 2022. And despite record authorizations for 2023, they’re also running negative year-over-year in the first quarter. Buyback trends rise and fall with the ease of credit and typically lead to capital expenditures, research, and development.

The decline to date is illuminating since we are just entering the second year of this monetary tightening cycle, and it’s not until year two that the bulk of policy effects are felt. Many loans and bonds were issued with fixed terms when rates were at record lows. So, the cost of carrying those debts has yet to jump. That’s coming next.

A recent study of non-financial companies in the S&P 500 found that the weighted average interest rate on their debt was 2.65%, much lower than companies have paid historically and a fraction of what they can borrow today.

A higher cost of capital is better for encouraging efficiency, sober risk management, and smarter allocation decisions, but it will be hard on profits and lofty asset valuations first. See, WSJ, Higher rates are coming for US companies:

In 1990, Federal Reserve data show that the interest paid by nonfinancial corporate businesses as a share of their outstanding debt, a proxy for the average interest rates they were paying, came to 13.3%. By 2021—the last year with available data—that had fallen to 3.6%, marking the lowest level since the late 1950s. Over the same period, long-term yields on Baa-rated corporate debt fell from 10.4% to 3.4%, according to Moody’s.

…So companies could have some difficult choices to make in the years ahead. Some will likely decide to reduce their debt loads, choosing either to curtail investment and expansion efforts, or to finance those efforts by other means, such as issuing equity. Others will refinance their maturing debt at higher rates, with higher borrowing costs weighing on earnings as a result. Neither of those possibilities seem all that pleasing to stock investors.

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