Another Trend Changes: Peak Debt for Blue Chip Companies, Buybacks Peak

American companies are the marginal buyer in the stock market, accounting for 2% of total market volume in February. They have been a consistent buyer of stocks since 2008, many using leverage at historically low interest rates to repurchase stock. Higher interest rates threaten this buying because companies will curtail their borrowing. Even without higher rates, some companies are hitting the point at which financial prudence dictates they stop leveraging their balance sheets. This leaves the companies financially impaired regardless of which way interest rates move because if they add more debt (holding equity constant), they will lose their investment grade status. Once that happens, their financial outlook sours and they could suddenly fall into financial trouble.

Bloomberg: American Companies Are in Love With Themselves

Stock buybacks, which along with dividends eat up sums of money equal to almost all the Standard & Poor’s 500 Index’s earnings, vaulted to a record in February, with chief executive officers announcing $104.3 billion in planned repurchases. That’s the most since TrimTabs Investment Research began tracking the data in 1995 and almost twice the $55 billion bought a year earlier.
Even with 10-year Treasury yields holding below 2.1 percent, economic growth trailing forecasts and earnings estimates deteriorating, the stock market snapped back last month as companies announced an average of more than $5 billion in buybacks each day. That’s enough to cover about 2 percent of the value of shares traded on U.S. exchanges, data compiled by Bloomberg show.

Investment News:Stock buybacks, now propping up the market, could become a victim of rising interest rates

Mr. Rice is among a growing chorus of market watchers who are warning that share buybacks will drop once interest rates start to move higher.

Higher rates are expected to put a damper on share buybacks on two main fronts. First, higher borrowing costs will slow the pattern of corporate borrowing for the purpose of repurchasing shares. Second, higher interest rates will likely mean companies will be able to find better uses for cash stockpiles, which, for companies in the S&P 500 Index, currently total $1.33 trillion.

“It's another reason higher rates will be bad for the stock market, because right now so much of share buybacks is driven by the interest-rate arbitrage that low rates enables,” Mr. Rice said. “Right now companies can borrow at cheap rates and use the proceeds to buy their own shares, and it all helps to explain why stock prices keep rising while investor interest has remained the same.”

This chart accompanied the article. The S&P 500 looks similar with a 3-month delay.

One of the companies that just hit its debt limit is Viacom.

ZeroHedge: After Viacom's "Shocker", These Companies Are Most At Risk Of Early Terminating Their Stock Buyback Programs

Which means that as soon as the buyback quiet period ends in the first week of May, the next catalyst concerned shareholders will focus on will be which company will follow in Viacom and IBM's footsteps, and likewise announce that in order to preserve their IG rating, will be "forced" to halt stock buybacks for the indefinite future.

To make our readers' lives easier, here is a quick and dirty CapIQ screen looking at the largest S&P companies which have repurchased $2 billion or more in stock in the last 12 months, and whose net debt/EBITDA is dangerously close to the "fallen angel" category. Not surprisingly, the top 20 results feature both IBM and Viacom. Expect many more companies on this list, especially those with higher net leverage, to announce that their stock buybacks are also put on hiatus until further notice, leading to a sudden and sharp air pocket in their stock price.

ZeroHedge has this chart of companies also likely to stop their buybacks due to hitting their debt limits: