As an economist, I know there is no such thing as a “shortage” of stocks. Demand always matches supply. But, the trick of course is figuring out what is the future demand and supply, and at what price those might clear. In the last twenty years, there has been an amazing change in the US stock market. The number of publicly traded stocks in the US shrank to 3,671 in 2016 from 7,322 in 1996. So, there are about half the number of publicly traded companies in which to invest than there were twenty years ago.
Obviously, there are many reasons for this. But, one of the most important is there have been significantly fewer initial public offerings (IPO’s) in recent years as a result of the high costs of regulatory compliance and a growing pile of private capital available to young companies. According to the American Investment Council, global private capital reserves are close to $1.5 trillion, up more than 50% since 2012. So, with all that money, companies find it cheaper, and a whole lot less trouble, to stay private much longer.
At the same time, with global interest rates at almost nothing, companies have leveraged their balance sheets (borrowed money) to buy other companies - leading to a reduction of the number of companies that are investable.
And, if that were not enough, companies have been buying their own shares with money borrowed at almost nothing. The amount of share buybacks for large, healthy companies is unprecedented.
Meanwhile, ETFs which are mostly passive index investors, have attracted billions of dollars. Most of the index funds ETFs emulate are capitalization weighted. That means that the largest companies in the index garner most of the new dollars from the growing ETFs, without regard to the fundamentals or valuation.
So, the net result of all of this is that there are only some 1500 investable companies in the US market. There is a “shortage” of stocks - at least compared to history. Haven’t you wondered why the talking heads on CNBC seem to be talking about the same companies over and over? There have been a few new companies funded, but almost all of them are Chinese. Looking at Investor’s Business Daily this weekend, six of the top fifteen ranked companies in the IDB 50 are Chinese.
So, what conclusions should we draw from this regarding the demand and supply for US stocks and the clearing price? I would say the demand for stocks remains at least the same, or stronger. Sovereign wealth funds like Norway, or the Bank of Japan continue to shift more funds from fixed income to stocks using index funds. If Saudi Arabia is able to sell a piece of Aramco in the spring, that money will go into global stocks. All of this will increase the demand for US and other large capitalization stocks. Meanwhile, the available pool of stocks shrinks.
It should be no wonder that stock valuations are a little high vs. history, especially with competing assets (bonds) offering historically low returns. It should also not be surprising that stock market volatility remains historically low. There are constant buyers and no real sellers.
This will continue until the central bankers of the world decide to have a unified position to reduce the huge monetary liquidity created since the “financial crisis.” The Federal Reserve has begun. Europe will be next, followed by Japan. I don’t know when, of course, but until then, don’t expect a Bear market.
There is some good news for us living on our savings (and pension funds, etc.). Interest rates are on the rise a bit. Expect the fed to raise rates more in December. When the rest of the central banks do the same, it will be time to be concerned about global stocks.
Robert C Davis is a Chartered Financial Analyst and is affiliated with Woodlands Asset Management, Inc. as a consultant. Founding partner of Davis Hamilton Jackson and Associates, a Houston based investment advisory firm; Bob is now retired and living in Caney Creek, Texas. He now lends his expertise and knowledge of the markets to our company and customers. We hope you find it interesting and insightful.