Repatriation May Make Tech Bonds Bigger Winners Than Stocks

(Bloomberg) -- Temper your enthusiasm that Donald Trump's tax reform could spur a buyback bonanza.

One key source of potential demand for share repurchases -- American companies with massive overseas cash holdings -- might have already been thoroughly tapped, argue Peter Boockvar, chief market analyst at Lindsey Group, and Brean Capital LLC head of macro strategy Peter Tchir.

U.S. stocks, particularly small-caps, rallied Wednesday as the president's tax blueprint was unveiled. Lawmakers are reportedly mulling a repatriation rate of 10 percent, though no figure is set in stone yet.

With interest rates low and investors hungry for yield, blue-chip firms with cash stockpiled from earnings abroad borrowed money to fund buybacks -- and, with the benefit of hindsight, potentially front-run the effects that a repatriation tax holiday.

Boockvar highlights Apple Inc., Microsoft Corp., Oracle Corp. and Cisco Systems Inc. as companies that have increased their debt burdens while simultaneously piling up cash,
much of it generated and held outside the U.S.

“In total over the past three years, these four companies have added $168 billion of cash to their balance sheets and $174 billion of debt," he writes. "Thus, one could argue that much of their repatriation has been spoken for via the rise in debt, which was then used mostly for stock buybacks."

The better way for investors to play the potential preferential treatment of profits returned to America's shores is to buy the longer-dated bonds issued by those firms, advises Tchir.

"Since these bonds seem fairly priced in this market -- I think you pick up some repatriation ‘tightening' possibility for little to no cost,” Tchir says. “Furthermore, depending on how the interest deduction limits are defined, there might be even less need to issue going forward."

That stands in contrast to the conventional wisdom on Wall Street, which has routinely trumpeted the effect repatriation would have on the equity market. For instance, strategists at JPMorgan Chase's year-ahead outlook for 2017 estimated that share repurchases fueled by repatriated cash could add about $1.30 to the S&P 500's earnings per share.

Stocks seemed to back up the contrarians' view, at least on Wednesday. A Goldman Sachs basket of S&P 500 Index stocks with the most permanently reinvested foreign earnings lagged the broader benchmark and a separate basket of firms with the highest propensity for buybacks relative to their peers by the most in two months.

Boockvar and Tchir still expect buybacks to provide a positive impulse for U.S. equities, but warn that it may not be as big as investors expect, nor might it come from the usual suspects. Boockvar, for his part, also warned of other headwinds to corporate profitability such as rising labor costs and borrowing costs.

Strategists at Morgan Stanley led by Adam Richmond noted that all else being equal, repatriation would dent investment-grade corporate bond issuance. But they also caution that other aspects of tax reform could foster more supply, leaving an unclear effect on the broader credit market.

"It is reasonable to assume that when tax reform is no longer a point of uncertainty, and the rules of the game are known, supply for M&A, as one example, could actually rise, offsetting some of the repatriation-driven decline in issuance," they write.

--With assistance from Allan Lopez

To contact the reporter on this story: Luke Kawa in New York at lkawa@bloomberg.net.

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Dave Liedtka, Andrew Dunn