Late last year, the Trump administration, along with Republican leadership pushed through the tax reform bill that lowered the income tax rates for most Americans, but really provided the biggest savings to corporate America. Crowing about their victory, Trump and friends predicted the tax savings would be plowed back into the economy, increasing factory orders, boosting jobs, and increasing pay in a way that would trickle down throughout the country. We’re five months into the year since tax reform went into effect, which means we’re starting to get more and more useful data about where that savings has been going. It might surprise you – or it might not, depending on your perspective – to find that while business spending has been healthy this year, it really hasn’t changed all that much from the last few years. What gives?
Tracking Business Spending
There are a variety of ways that economists like to measure business spending. One simple method is to track wage growth. When unemployment drops and remains low, as it has for the last two years, when it first dropped below 5% in May of 2016, it’s pretty normal to see wages start to pick up. Fewer unemployed workers means that employers have to compete for top talent, and that usually forces companies to increase wages. That hasn’t really happened; the latest unemployment report from the beginning of May showed an increase in wages of only 0.1% for the entire month of April, and an annual pace of only 2.6%. While continued low unemployment continues to be a healthy thing, the lack of wage growth is a puzzle that still has economists scratching their heads to find an explanation. No matter what the cause, it’s safe to say that Corporate America isn’t using its tax windfall to spread the wealth to its workers.
Another popular measure is non-defense capital goods orders. Capital goods generally includes machinery, equipment, office supplies and furniture, computers, and just about anything else a business needs to operate (it does not include aircraft and defense). Spending in this area increased in 2016 and 2017, but so far this year is actually somewhat lower. Increased capital goods orders generally implies companies are investing in their own infrastructure, which should translate to increased operating efficiency in the long run. When it doesn’t grow, it usually means that companies are actively choosing to make do with what they already have as a way to save money, instead of allocating portions of their tax savings to making internal improvements.
The absence of capital goods spending growth as an indicator that things aren’t growing like they normally would be expected to is supported by an absence of small business spending. The National Federation of Independent Business measures the percentage of business owners who plan to increase spending on equipment or facilities within the next three months. This measurement is down more than 10% since August of 2017. Trickle-down theory suggests that if big business is increasing their capital goods spending, they’ll be using smaller businesses to fill a lot of those orders, which then prompts those businesses to do the same.
Other uses for tax savings
These are just a few simple indicators, but the truth is that no matter how you slice it, to this point corporate America just isn’t putting their money where Trump’s mouth said it would be. At the same time, it’s hard to fault companies who are so far choosing to be more conservative about the way they spend their money; after all, any smart business owner is only going to spend money if there is strong evidence that he’ll see a better return on that spending than in using the money in other ways. It makes sense that an increasingly protectionist administration, along with the ongoing threat of a trade war would naturally put multinational U.S. companies on edge and prompt them to proceed very carefully with any extra cash they have. A survey in February of S&P 500 companies put available cash and liquid assets more than 66% higher than the same point in 2017, suggesting that while companies may be flush with cash, they are also very selective about what they are going to do with it.
If investing tax savings back into their business doesn’t make sense, the natural question is where corporate America is finding more useful options. One natural avenue is in mergers and acquisitions. In just the first two months of the year, global M&A volume was more than $449 million, more than 21% higher than the year before. There are still a number of large, high-profile deals pending, including the proposed purchase by Disney (DIS) of the bulk of 21st Century Fox Studio’s (FOX) assets and CVS Health Corporation’s (CVS) proposed acquisition of Aetna Healthcare (AET).
Another avenue a lot of businesses are directing their tax savings into is to direct it to shareholders in the form of stock buybacks and dividend increases. Stock buybacks decrease the number of available shares, which provides support to prices and can even drive them higher. In the first quarter of the year, U.S. stock buybacks hit an all-time record high at more than $187 billion. Dividend distributions also increased the most since 2014. Combined, the total dollars returned to shareholders over the last twelve months totaled more than $1 trillion.
The truth is that companies have been seeing big benefits as a result of Trump’s tax reform. While they haven’t as yet been using that savings as originally predicted and anticipated by many, it is also true that they have still been finding useful ways to direct that money to work for them. The goal for the smart investor is to identify how that money is being used and to figure out how they can use that information to make smart investments.