Repatriation: No Matter What, Investors Win

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With tax reform now a done deal, investors and analysts alike are scouring over what the new policies will mean, and what companies will do with all this newfound wealth. One of the major changes now allows companies to bring back the cash they’ve been holding overseas at a lower tax rate of 15.5%.

This process, dubbed repatriation, could have a huge impact on the bottom lines of companies. Recent estimates by Goldman Sachs suggest that American companies may be sitting on nearly a trillion dollars of overseas cash. Other estimates put that figure as high as $2.5 trillion.

Companies must now pay this tax regardless of whether they actually bring those cash hordes home or not, which means there’s a good chance much of that money will be coming home. But what are these corporations likely to do with it?

Will they invest in research and development, and plant, property, and equipment to boost productivity? Or will they do more financial engineering by paying off debt, boosting dividends and buying back shares?

In order to gain some insight on what corporations are likely to do with this cash, it helps to review what happened during the 2004 tax holiday. This tax break, which was part of the American Jobs Creation Act, allowed qualifying companies a one-time opportunity to repatriate overseas cash at a 5.25% tax rate. This is the only other time there has been a tax break on repatriated assets.

FactSet recently did an in-depth analysis of the effects of this one-time tax break on S&P 500 companies and found some rather interesting findings:

  • In 2003 (the year before the tax break) $30.3 billion worth of special dividends were paid to shareholders of S&P 500 companies. In 2004, that figure jumped to $179.4 billion, an increase of 492%. In 2005, special dividends fell back down to $49.2 billion.

  • During 2003, share repurchases among S&P 500 companies amounted to $115 billion. That figure grew to $202.7 billion in 2004 and $336.5 billion in 2005.

  • On the investment side (the part that actually stimulates the economy and creates jobs etc.), things look a little bleaker. In 2003, S&P 500 companies spent $372 billion on capital expenditures (CAPEX). That figure rose to $385 billion in 2004 and $436 billion in 2005.

All told, the big takeaway from the 2004 tax holiday is that roughly 80% of repatriated earnings went to benefit shareholders through dividends and share repurchases. Only 20% actually flowed into the economy in a way that would benefit Main Street, as opposed to Wall Street.

But, of course, you already knew this … You know how Wall Street works, and Wall Street has never looked out for mainstream America. S&P 500 companies are run by wealthy and talented individuals who are incented to raise their stock prices at nearly any cost. Unfortunately, returning capital to shareholders in the form of dividends and share repurchases is one of the safest and most effective means of accomplishing this.

If you consider yourself to be a “little guy,” and relate more to Main Street than Wall Street, this may piss you off. But it really shouldn’t. These corporate leaders do not have a fiduciary responsibility to improve the economy, or to help close the wealth gap; their fiduciary responsibility is to shareholders only, and it involves maximizing shareholder value.

As a result, we can’t blame these corporate leaders for making these types of decisions … put in their shoes, there’s an extremely high probability we’d each do the same. So the best course of action is simply to align ourselves with their interests, and profit while there are profits to be made.

Whether you want to admit it to yourself or not, this whole tax reform package was designed to benefit the wealthy, not the middle or lower class. Giving mainstream America an inch worth of tax breaks so that corporate America can take a mile should not be considered a tax break for the working class, even if technically it is.

But alas, when it comes to our money, it’s best to keep politics out of the equation and focus squarely on the landscape in front of us. That landscape reveals an environment in which corporations now have advantages that they previously didn’t. With the playing field even more tipped in favor of large corporations, it’s no surprise we’ve seen such a melt-up in stocks.

While we’re on the topic of a melt-up, something else comes to mind. This administration, and Trump in particular grade themselves using the stock market. When the Dow Jones Industrial Average crossed 25,000 on an intraday basis (even before the market actually closed above that level), Trump was in front of cameras touting this accomplishment and calling for Dow 30,000 …

Those who have followed the markets for many years are familiar with the old saying “don’t fight the Fed.” Ultimately, what this phrase boils down to is that it’s a bad idea to fight the intentions of such a big market player – one that ultimately determines short-rates, which have far-reaching implications across the entire economy.

But now, it seems there’s a new big market player in town – the Administration – and I’m beginning to wonder if the same mentality is warranted. From what I can tell, Trump’s primary goal is to make himself, and his fellow affluent cohort, as absolutely rich as possible. Even after his term(s), I can see Trump bragging about how he was the greatest president in history because he created more wealth than anyone else (even if it’s not true, of course).

For Trump, everything is about wealth, and in my humble opinion, he’s restoking a flame inside capitalists that has been diminished for some time. This is both good and bad. In the short-run, we know that markets are heavily driven by investor psychology and this boost of optimism (or greed, whatever you want to call it) can be very powerful.

But in the long-run, this reckless pursuit of profits is what ultimately allows too many excesses to build in the system, leaving us with another house-of-cards scenario down the line. It’s the yin and yang – do we grow slowly and sustainably over time? Or do we burn all the oil and party like it’s 1999?

Trump knows he’ll only be around for four or eight years max, and from what I can tell, he’s going to ignite every growth catalyst he can get his hands on. This, of course, sucks for future generations, and future economic growth, and the environment, but as the old saying goes … if you can’t beat ‘em, join ‘em.

If the Trump administration is going to use every weapon in their arsenal to boost stock prices and make each other rich, then we all owe it to ourselves to take part. We can fight the battle with our consciences later; for now, we need to allow this melt-up to benefit us until price action says otherwise.

The preceding content was an excerpt from Dow Theory Letters. To receive their daily updates and research, click here to subscribe. Matt is also the Chief Investment Strategist at Model Investing. For more information about algorithmic based portfolio management, click here.

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About Matthew Kerkhoff

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