Who is Supporting the Stock Market?
Financial markets are complex, but ultimately their movements reflect the basic economic concept of supply and demand. Understanding who’s buying, selling and why, provides insight into what’s driving the market and the conditions that are supporting it. As it stands today corporations have been the largest buyer in the stock market providing outsized support.
Corporations are Supporting the Stock Market
Over the last few years the single largest source of demand for US equities has come from corporate buyers. In fact, since 2016 corporations have purchased over $2 trillion of stock while cumulatively all other investors have sold over $1 trillion.1 While last year’s corporate tax cuts have added fuel to this fire, we believe low interest rates have been the primary driver of these purchases. These low rates have made it extremely attractive for corporations to use debt to buy back their own shares at a low borrowing cost. This activity has reduced supply, increased demand, and as a result, increased stock prices. Companies prefer to use debt for these repurchases in this low interest rate environment because they know that that their gains as a result of the repurchases will significantly exceed the borrowing cost of the debt.
It is unusual to have concern about a rising stock market, but we do believe markets would be much healthier today if they were to be supported by a more diverse base of investors. All other investor types since 2016 have been net sellers in the market. This means that if corporations were to become net sellers — or even just become less prominent buyers — the support to the market could become compromised resulting in a sell-off.
Who is Buying Equities?
Net US Equity Demand
Source: Goldman Sachs via MarketWatch, net US equity Demand 1/1/2014 – 10/21/19
Can it Continue?
Companies have been using most of their profits to maximize value for shareholders in the short term through buybacks and dividends. If done in excess this activity can negatively affect long term health if the economy enters a downturn. If profits take a dip, these companies might not have enough cash to be able to service these large debts that have been taken on to fund these repurchases and dividend payments.
Up until 1982 stock buybacks were illegal since they were considered to be a form of stock manipulation. There are current presidential candidates that plan to introduce legislature that would render stock buybacks illegal. If this legislature gets passed, corporations would no longer have this tool to use as a way to inflate valuation. Without this tool at their disposal valuations could revert back to “honest” fundamentals which we believe would cause a significant correction in stocks.
Whether the market continues to go up or if these unhealthy market fundamentals begin to show their color, using our proprietary rules-based risk management approach we are always monitoring market conditions; and we are prepared to systematically adjust portfolios with the aim of protecting against large market declines. Taking this measured approach to market volatility has historically been a productive way to reduce portfolio risk and enhance risk-adjusted returns.
1) Source: Goldman Sachs ova Marketwatch, net US equity Demand 1/1/2014 – 10/21/19
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