Last week, we showed what may soon be perceived as the most dramatic consequence of the Trump tax reform on the bond (and stock) market: corporate bond issuance for cash-rich companies, those that until recently held hundreds of billions in cash in offshore accounts, had frozen with not a single bond issued so far in 2018.
The reason was simple: whereas previously cash-rich companies which held most of their “cash and marketable securities” offshore (technically this definition was meaningless, as said securities were mostly in the form of bonds), and inaccessible due to the high repatriation tax, they were forced to issue domestic bonds to fund buybacks, dividends SG&A and/or domestic capex, following passage of Trump tax reform, they would be allowed to repatriate this offshore cash domestically (paying a modest one-time charge), and no longer be reliant on the bond market.
In other words, these cash-rich companies would finally start spending their “cash” (mostly on buybacks, less on CapEx) which really wasn’t “cash” at all, but cash equivalents such as Treasurys, corporate bonds and in some cases equities: effectively launching a form of Quantitative Tightening.
Here Goldman provided some context: of the companies with large overseas cash holdings, the top eight held $750 billion by year-end 2017. “Exhibit 2 details the size and breakdown (by major investment type) of these companies’ investment portfolios. With a total of $328 billion invested in short-dated IG corporate bonds, cash-rich companies own roughly 13% of the total $2.6 trillion universe of index-eligible investment grade bonds with maturities shorter than 5 years. “
The implication of this historic reversal in bond market dynamic were dramatic, because while the Fed may be withdrawing only modest amounts of liquidity from the capital market so far, Trump’s tax reform has had a far more pronounced impact on overall market liquidity, by way of the private sector, where net debt destruction – is now the order of the day, as companies no longer issue debt to fund buybacks, but instead sell existing debt securities to fund operations and/or shareholder friendly activities.
Incidentally, this reversal also has a profound impact on funding markets, and also explains why the Libor-OIS spread has so far failed to tighten nearly 1 month after the end of the massive T-Bill supply onslaught which so many said was the catalyst for the blowout in L-OIS, and suggests that unless something materially changes in terms of corporate liquidity preferences, financial conditions will remain especially tight.
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We bring up the above because yesterday we got the most vivid example of this theory taking place in the real world, courtesy of Apple, which as we noted previously just reported the first drop in its record cash holdings in three years:
Only, of course, it wasn’t “cash”, but rather cash equivalents, i.e., corporate bonds and other marketable securities.
And, as Bank of America points out this morning, for the first time in years, Apple has turned into a net seller. Here is the take of BofA’s Hans Mikkelsen:
Apple’s earnings release today and investor call after the close highlighted that anything is possible regarding capital plans. They did announce a new $100bn buyback program (in addition to $10bn remaining under the old one), which was more than the $75bn our equity analysts expected. While the company plans to execute the program efficiently and at a fast pace no time frame was given. We note that Apple reported having repurchased $23.5bn in shares in the March quarter.
Between debt maturities, tax payments to Ireland, buybacks, a 16% increase in dividends, possible M&A, etc. is difficult to estimate how long it will take Apple to consume its net cash position.
And the punchline:
In terms of impact on the short maturity fixed income market we note that Apple in the March quarter turned net sellers (purchases-sales- maturities) of marketable securities for the first time in at least three years (for as long as we could quickly find data) to the tune of $22bn.
What does this mean? Well, as BofA explains, in previous quarters, the company was a net buyer of $32bn/quarter on average.
Hence, Apple’s impact on the fixed income market already is a decline in support of $52bn/quarter, which is money that needs to be found elsewhere. Gilead added to the number of companies with meaningful declines in cash despite no guidance.
And, as the following table shows, expect a tide of “cash-heavy” companies to deep freeze their bond sales for years, certainly until such time as their cash levels – used largely to fund stock buybacks – drop low enough and need to be replenished.
Until then, however, what will happen is effectively the equivalent of Quantitative Tightening, if for the private sector, where net debt creation will hit a brick wall, and even go into reverse once already issued debt matures, in the process soaking up trillions in hundreds of billions from the overall market. For those still curious why stocks are unable to rise despite the best earnings quarter in 7 years, the very real tightening in the bond market that has resulted as a result of Trump’s tax reform, may be the explanation.
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