Two months ago, in early January, when forecasting the source of funds for US stock purchases, Goldman calculated that of the $1 trillion in total demand for calendar 2017, the vast majority. or some $800 billion would come from corporate buybacks, with the balance, or $200 billion would be sourced from ETF demand. Fast forward to this weekend, when Goldman’s David Kostin has revised his buyback forecast, and now expects that corporation will repurchase $100 billion less of their own shares, reducing the total to $700 billion, because corporate tax reform is likely to be delayed. As we reported previously, Goldman had expected $150 billion of buybacks as a result of a one-time tax relief on foreign profit.
The reason for the forecast cut is that Goldman now expects that Trump’s tax reforms will be substantially delayed, and not take place until late 2017 or even early 2018, due to the delays facing Trump’s various other domestic agenda items, first and foremost the repeal of Obamacare.
Nonetheless, the new forecast still represents a 20% increase from 2016, when a total of $584 billion in corporate buybacks took place.
Here is the summary from Kostin:
In 2016, corporations and ETFs were the key drivers of positive US equity demand, purchasing almost $800 billion of equities. In contrast, mutual funds, pension funds, households, and foreign investors were net sellers. In 2017, we expect history will repeat itself. Although we lower our corporate demand forecast by $100 billion, to $700 billion, net buybacks will grow by 20% in 2017. ETF equity purchases will equal $200 billion this year while mutual funds, households, and pensions will remain net sellers…. We lower our 2017 forecast of corporate equity demand by $100 billion, to $700 billion, given our Washington, D.C. economist’s expectation for a delay in corporate tax reform. However, corporations will remain the primary source of US equity demand this year.
Finally, Kostin writes that since such pure yield strategies as buybacks are at risk during periods of rising interest rates, that Investors should favor dividend growth stocks.
Here are select excerpts from the Goldman note:
Corporations and ETFs were the key drivers of US equity demand last year. Net equity purchases by corporations and ETFs equaled $584 billion and $188 billion, respectively, which offset net selling by mutual funds, households, and pension funds. Foreign investors also fled US equities during 2016, including $60 billion of net selling post-election amidst concerns of potential protectionist policies proposed by the Trump Administration.
In 2017, we expect history will repeat itself. Corporations and ETFs will continue to drive equity demand while mutual funds, households, and pension funds will remain net sellers of equities.
We lower our 2017 forecast of corporate equity demand by $100 billion, to $700 billion, given our Washington, D.C. economist’s expectation for a delay in corporate tax reform. However, corporations will remain the primary source of US equity demand this year. Our prior forecast assumed a one-time tax on untaxed foreign profits would occur in 2H 2017, resulting in an additional $150 billion of buybacks as firms repatriate overseas cash. However, we now expect corporate tax reform will not occur until in late 2017 or early 2018. Given this delay, we now estimate firms will only repatriate $60 to $70 billion of overseas cash this year and spend $50 billion (around 75%) on share buybacks.
ETF equity purchases will equal $200 billion given continued investor preference for passive vs. active management. Total inflows into equity ETFs equal $66 billion YTD vs. $23 billion of outflows from equity mutual funds. ETF ownership of the corporate equity market is at an all-time high (5%) while mutual fund ownership (24%) is at its lowest level since 1Q 2004.
We expect mutual funds will remain net sellers of equities ($50 billion) given investor outflows and low liquidity. Mutual fund liquid assets as share of total assets are near historical lows (3% as of Jan 2017). However, higher dispersion and improved fund returns YTD suggest that mutual fund demand in 2017 (-$50 billion) will be higher than in 2016 (-$117 billion).
Pension funds will sell $175 billion of equities during 2017 alongside rising interest rates. We expect the 10-year US Treasury yield will equal 3% by year-end. Households will be net sellers of equities due to the surge in share repurchases. Given our forecast of $700 billion of net buybacks, we expect that Households will be the key sellers to companies ($300 billion).
Finally, going to the heart of the active vs passive investing debate, Goldman points out that in 2016, the ETF share of the equity market at an all-time high; meanwhile allocation to mutual funds continues to decline, and the end result may be tht mutual funds sell far more than the $50 billion that Goldman forecasts, mostly driven by the ongoing surge in redemptions.