One of the major claims made during last year’s tax reform debate was that the new rules would motivate multinationals to repatriate all their cash back to the US, fueling a surge in investment spending. The claims appeared to be vindicated early this year, with Apple announcing that they will bring back most of their overseas dollars. As Alexandra Scaggs put it in an FT Alphaville piece, one would get the impression that Apple and other firms would be sailing ships from Ireland to the US, filled with cash.
Back in December 2017, we pointed out that companies simply do not let most of their cash sit idly in an Irish (or any other tax haven) bank account. Instead, they invest most of their overseas cash in marketable securities – mostly US treasury and corporate bonds, which means the cash is already funding government and corporate activity within the US. In Apple’s case, repatriation means that its cash will move from a foreign account to a US based account after repatriation taxes are paid. It will presumably be managed by the same Nevada unit that was set up in 2006 to manage Apple’s cash hoard (possibly the world’s largest hedge fund today).
The repatriated cash will fund activities made by the companies themselves, like investments, acquisitions, stock buybacks, dividends and debt repayment. However, it also means that these companies will no longer be a lender to the US government or other US corporations, or at least, not in the same capacity as before – with potential implications for the bond market.
A follow-up article by Scaggs noted that macro strategists at Credit Suisse estimate multinationals will liquidate and deploy $800 billion of their offshore investments by 2020 ($400 billion each in 2018 and 2019).
This process may have started.
We pored through publicly available 10-Qs for the top six technology firms that have foreign units – Apple, Microsoft, Google, Facebook, Cisco and Oracle(labeled “Tech 6” from here on) – to see how their investment activities have changed, if at all, in the first quarter of 2018 (Q1 2018). We use these six companies as a proxy since their cash hoard constitutes 70-80% of cash held overseas by US multinationals.
As the next exhibit illustrates, net quarterly purchases of marketable securities, which excludes cash and cash equivalents, saw their first significant drop in five years.
Total cumulative growth of marketable securities (excludes cash and cash equivalents) for the “Tech 6” (Apple, Microsoft, Google, Facebook, Cisco*, Oracle**) from January 2013 through March 2018 (quarterly data). Source: SEC Edgar Database.
Between 2013 and 2017, the “Tech 6” grew their portfolio of marketable securities by $338 billion – from $281 billion to $619 billion. However, Q1 2018 saw this total portfolio shrink by about $52 billion. That is more than a 15% drop in their cumulative five year buildup.
Apple saw the largest drop, with its holdings falling more than $35 billion, from $257.6 billion to $222.2 billion. The following table shows the size of each company’s portfolio of marketable securities.
If the “Tech 6” continue reducing their holdings at this pace, they will completely erase their five-year buildup in less than two years.
Digging a little deeper into the 10-Qs also told us how the portfolios of marketable securities for each of the six companies break down – into US treasury, US agency, non-US government, corporate debt and asset-backed securities, as well as equities.
Over the five years between 2013 and 2017, the“Tech 6” invested close to 60% of the $338 billion buildup in marketable securities into corporate bonds (about $202 billion), while another 36% was invested in treasury securities (about $122 billion). While both of these were reduced quite significantly in Q1, let’s take a look at each separately.
Apple starts to move out of the corporate debt market
The big story here is Apple, which was responsible for more than half the five-year buildup in corporate bond investments by the “Tech 6”, accounting for $107 billion of the $202 billion total. Close to 80% of Apple’s portfolio buildup over five years was invested in corporate debt – its corporate debt holdings grew from less than $50 billion at the end of 2012 to more than $156 billion by the end of 2017.
The next largest were Oracle and Cisco, whose corporate bond investments rose by almost $44 billion and $24 billion, respectively, over the five years.
However, Q1 2018 saw a shift, with corporate bond investments in the “Tech 6” portfolio falling by $23 billion. Apple alone accounted for more than $20 billion of the pullback.
Total cumulative growth of corporate debt securities as part of marketable securities (excludes cash and cash equivalents) for the “Tech 6” (Apple, Microsoft, Google, Facebook, Cisco*, Oracle**) from January 2013 through March 2018 (quarterly data). Source: SEC Edgar Database.
The good news is that corporate bond issuance is falling even as these technology firms start to shrink their corporate bond portfolios. Investment grade corporate bond issuance fell almost 15% over the first five months of 2018 compared to the same period in 2017, while high yield issuance has fallen close to 27% over the same period.
Now the same cannot be said for US treasuries.
A major player in the treasury market steps back
The “Tech 6” grew their portfolio of treasury securities from $119 billion at the end of 2012 to almost $241 billion by December 2017, a buildup of $122 billion. However, Q1 2018 saw these treasury holdings trimmed by almost $18 billion. Note that these numbers exclude any treasury securities that are part of cash equivalents, and so the actual treasury holdings may be slightly larger.
Amongst the six companies, Microsoft is the largest holder of US treasuries, which were valued at $113.9 billion at the end of 2017 (reduced to $106.7 billion in Q1). Apple was next largest, with a treasury portfolio valued at $57.6 billion as of December 2017 (reduced to $49.4 billion in Q1).
To get a sense of the relative size of the “Tech 6” treasury portfolio, we compare it to major foreign holders of treasuries. If “Tech 6” were a major country, it would rank as the 8th largest holder of treasury securities as of March 2018. As the chart shows, the “Tech 6” have become a relatively larger player in the US treasury market since 2012.
Now, treasury holdings for the “Tech 6” are not exclusive of countries in the above chart, most notably Ireland – which is now the third largest foreign holder of US treasuries. Ireland, and other tax havens like Switzerland, Cayman Islands and Luxembourg have seen their treasury holdings grow thanks to multinationals based in these countries reinvesting a chunk of their overseas profits into these securities.
Along this same vein, we thought it would be interesting to look at the growth of treasury security purchases from seven major tax havens – Ireland, Switzerland, Cayman Islands, Luxembourg, Singapore, Bermuda and the Netherlands – which would largely be a function of US multinationals reinvesting some of their profits from those locales in order to defer US taxes (prior to the 2017 tax reform).
The next chart, which shows cumulative growth in treasury securities in the tax havens versus everyone else (foreign holders) between January 2013 and March 2018, indicates that most of the foreign demand has indeed come from these seven tiny countries. Foreign holdings of treasuries increased by $720.2 billion over this period, with the tax havens accounting for almost 60% of that growth ($430.6 billion).
Total cumulative growth of treasury securities in seven major tax havens (Ireland, Switzerland, Cayman Islands, Luxembourg, Singapore, Bermuda and the Netherlands) and the rest of the world from January 2013 through March 2018 (quarterly data). Source: Treasury TIC Data.
Treasury holdings in the tax havens (blue bars in the above chart) grew even as the rest of the world (orange bars) reduced their holdings of treasuries in 2015 and 2016, mostly thanks to China as it battled capital outflows and a depreciating currency.
What is interesting is that over the past few years, the tax havens covered some of the slack created by the Federal Reserve when they ended their bond buying program (in October 2014), and China’s lower demand for treasuries.
The tax havens, or rather, US multinationals based there, have clearly played an important role in the US treasury market since 2014, just as the Fed and China started to reduce their relative treasury holdings.
However, if Q1 2018 is any indication, this may be coming to an end. The Federal Reserve is also expected to pick up the pace of reducing their treasury holdings this year. China has started to rebuild its treasury portfolio (as part of reserves) over the past year but the pace is much slower than what we saw prior to 2014. The chart below shows treasury holdings for the Federal Reserve, China and the seven tax havens as a percent of total marketable US treasury securities, to give you a sense of how demand from these entities have changed.
So we have three major players that have bolstered the treasury market over the past several years stepping back now, just as the US is increasing its issuance of treasuries to cover the rising fiscal deficit. In other words, the three lines in the the previous chart are going to be heading down at a faster rate.
At the same time, as the Fed raises rates while Europe and Japan hold rates below zero, the differential between US and foreign yields will climb, perhaps inducing more investors to snap up treasuries. Also, the scarcity of other “safe assets” (especially in Europe) means that there may still be demand for US treasuries, especially in risk-off situations. Brad Setser, an economist and Senior Fellow at the Council on Foreign Relations, recently wrote a very interesting piece on how the US will fund its twin deficits – the budget and the trade deficit.
Of course, one quarter does not make a trend. Nevertheless, perhaps it is no surprise that the bond yields have risen this year, and if what we saw above continues at the same rate, the bond market could remain under pressure for a while. We will definitely be keeping an eye on this.
* Cisco latest reported quarter ended in April 2018.
** Oracle’s latest reported quarter ended in February 2018.
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