Who is Supporting the Stock Market?

Dec 2019

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

Blue Square Wealth is a SEC-Registered Investment Adviser. A copy of the Firm’s Current Disclosure Brochures can be found on the SEC’s IAPD site or may be requested at any time by contacting us. Registration of an investment adviser does not imply any specific level of skill or training and does not constitute an endorsement of the firm by the Securities and Exchange Commission.

All investment strategies have the potential for profit or loss; changes in investment strategies, contributions or withdrawals may materially alter the performance and results of a portfolio. Different types of investments involve varying degrees of risk, and there can be no assurance that any specific investment will be suitable or profitable for a client’s investment portfolio. Past performance is not indicative of future returns.

Significant risk may accompany investments in stocks, bonds or other asset classes over short periods of time. Investment return and principal value will fluctuate with changes in market conditions. Your investment may be worth more or less than your original cost. Past performance is not indicative of future results.

This blog is a publication of Blue Square Wealth. Information presented is believed to be factual and up-to-date, but we do not guarantee its accuracy and it should not be regarded as a complete analysis of subjects discussed. All expressions of opinion reflect judgment of author as of date of publication and are subject to change. Information contained herein does not involve rendering of investment advice. A professional adviser should be consulted before implementing any of strategies presented. Information is not an offer to buy or sell, or a solicitation of any offer to buy or sell securities mentioned herein. Different types of investments involve varying degrees of risk. Economic factors, market conditions, and investment strategies will affect performance of any portfolio and there are no assurances that it will match or outperform any particular benchmark. This document may contain forward-looking statements relating to objectives, opportunities, and future performance of U.S. markets generally. Forward-looking statements may be identified by the use of such words as; “believe,” “expect,” “should,” “potential” and other similar terms. Examples of forward-looking statements include, but are not limited to, estimates to financial condition, results of operations, and success or lack of success of any particular investment strategy. All are subject to various factors, including, but not limited to economic conditions, changing levels of competition in industries and markets, changes in interest rates, and other economic, governmental, regulatory and other factors affecting a portfolio’s operations that could cause results to differ materially from projected results. Such statements are forward-looking in nature and involve known and unknown risks, uncertainties and factors, actual results may differ materially from those reflected in forward-looking statements. Investors cautioned not to place undue reliance on forward-looking statements / examples. None of Blue Square Wealth or any affiliates, principals nor any other individual / entity assumes any obligation to update any forward-looking statements as a result of new information, subsequent events or any other circumstances.