(Bloomberg Opinion) -- Higher interest rates from the Federal Reserve's efforts to get a handle on inflation have contributed to the stock market's worst start to the year since 1939. That's bad news for investors, but the market signal being sent to corporate America is good news on the inflation front.
Lower share prices are encouraging companies to buy back stock rather than spend their capital on inflation-stoking activities such hiring and investing in their business. We don't want this shift to last forever, but it's a welcome development until inflation is tamed.
One example is homebuilding companies. Earnings and book-value growth have been strong over the past year. Even with the supply-chain problems the industry has faced, homes sold at high prices and fat profit margins. Yet because investors are worried that higher mortgage rates will hurt the housing market, the stocks have fallen significantly. Many are trading below book value — meaning that in theory, the companies would get more money from liquidating than they would get from selling all their stock.
Perhaps because of that, the homebuilder KB Home announced a $300 million buyback a few weeks ago. That $300 million could have been invested in land, labor or building materials, but all of those are in scarce supply and expensive, and the company believes shareholders are better off for now if the money is spent on buybacks instead. And by not spending that money on things that go into the production of homes, the company is putting less upward pressure on inflation.
Management teams are starting to be asked pointed questions on earnings calls about their capital allocation choices given the stock market turbulence. The chief executive officer of Park Hotels & Resorts this week said that in management's eyes, the company's shares are trading at such a discount that a "highest and best use of available cash" includes buying back stock. In other words, they believe it makes more sense to buy back their own stock than build a less-profitable hotel.
Tech giants Alphabet Inc. and Apple Inc. also have announced large buybacks — $70 billion and $90 billion, respectively. One can imagine the inflationary impact it would have if the two companies instead decided that they would invest tens of billions of dollars in fulfillment centers, new trucks and workers to compete with Amazon.com Inc.
The whole point of the Fed's interest rate hikes is to bring the economy back into balance by aligning supply and demand, thereby returning inflation to a more comfortable level. Consumers respond to higher interest rates by putting off major purchases like automobiles and homes; Companies respond to lower stock prices by doing buybacks rather than hiring and investing.
What we want right now is continued economic growth, but not so much that it pushes inflation higher. That’s what a soft landing is all about. Bidding wars for homes and aggressive corporate expansion plans aren't helpful in this environment. So we should welcome the shift to buybacks until inflation cools down somewhat.
In the longer run, the solution to inflation that stems from a capacity-constrained economy is to build more capacity. If we're going to avoid housing bidding wars and soaring apartment rents we need companies to build more housing units, even if that construction has an inflationary effect. If travel and leisure demand is growing, we want companies to build more hotels. And we're not going to make our economy more productive and efficient without the kinds of innovations that the technology industry has invested in time and time again.
For now, though, stock buybacks and a soft landing might be the best case scenario. Later we can talk about the need for companies to be more ambitious.
More From at Bloomberg Opinion:
- The Fed Faces Its Own Miracle on the Hudson Moment: John Authers
- Why the Federal Reserve Keeps Underestimating Inflation: Allison Schrager
- The Amazon Economic Indicator Says Inflation Is Easing: Conor Sen
- GE and 3M Lead Worry Parade on the Economy: Brooke Sutherland
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Conor Sen is a Bloomberg Opinion columnist and the founder of Peachtree Creek Investments. He's been a contributor to the Atlantic and Business Insider and resides in Atlanta.
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