Stock market bulls are needlessly worried about the recent record pace of new stock issuance. In fact, if you look at it correctly, the current pace of stock issuance is neutral – if not slightly bullish – for the stock market.
In other words, what for some is a sign that a bubble is about to burst may in fact be a little closer to the opposite.
Let's start with the numbers. New equity issues by US non-financial corporations amounted to $ 582 billion in the past four quarters, according to the Federal Reserve. That is a record by far. The previous record stood at the top of the internet bubble in the late 1990s, when the comparable total was $ 354 billion. The pace of late is more than 60% faster than it was then.
Just matching records at the top of the internet bubble would be scary enough, let alone breaking those records by 60%. And it makes sense that high levels of stock issuance would be bearish: companies have a better grasp than the rest of us when their stocks are overvalued, so this is a red flag when they're eagerly issuing new stocks.
The reason record stock issuance may not be bearish is because there has been a high volume of share buybacks (or buybacks) as well as mergers and acquisitions. Any of these other activities are the opposite of issuing new shares as they reduce the number of shares outstanding. Record stock issuance is not necessarily bearish when accompanied by heavy buybacks or M&A activity.
That means we need to focus on net, not gross, emissions. A completely different picture emerges here. In fact, according to Federal Reserve data through the first quarter of 2021 and more recent data from TrimTabs, net sales for non-financial corporations are negative – as they have been for many years. This means that, on balance, non-financial corporations withdraw more shares than they spend.
The current chart shows the data from the Federal Reserve. Note that the last positive net issuance was in early 2009, at the bottom of the bear market that accompanied the global financial crisis. These two series were near equilibrium during the economic lockdown a year ago, but that was short-lived and net sales are now solidly back in negative territory.
For stocks, is it a good sign that net sales are negative? Perhaps, according to a 2018 study by the Financial Analysts Journal entitled "Net buybacks and the seven dwarfs. ”The authors of this study found that net issuance explains most of the differences in equity returns across countries over the past few decades.
Note that the authors did not investigate whether net emissions were explanatory in the short term. To fill this gap, I measured the correlation between net issues and the S&P 500
subsequent real total return. I focused on issuance over periods from the last quarter to the last three years and the subsequent return of the S&P 500 over periods of just one quarter to three years. My database covers all years since 1988.
In my search for statistically significant correlations, I was left blank, regardless of the length of the periods measured.
The conclusion I draw is that it is going too far to interpret recent net sales trends as downright bullish on the stock market outlook. But at least the bulls can take some comfort in knowing that stock issue data isn't screaming that a bubble is about to burst.
Let me quickly add that the stock market could still bubble. Of course, net sales aren't the only indicator out there. The point of this column is that issuing shares is not an additional reason to believe that such a bubble is forming. But it is strange that some of those who believe a bubble is forming should rely on such an obviously misleading argument.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert ratings track investment newsletters that pay a flat fee for testing. He can be reached at email@example.com
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