Equity pool poised to end nine straight years of contraction
Watch out for IPO tipping point on market warnings: Hogan
Voracious cash appetite among virus-strapped companies and a battered economy that makes buybacks tough to justify are warping supply and demand dynamics in the stock market, something for bulls to worry about heading into year end.
While American firms normally repurchase way more stock than they sell, this year has been different, as offerings by everyone from Snowflake Inc. to Warner Music Group Corp. flooded the market with shares. Companies hurt most during the pandemic, from airlines to cruise lines, are rushing to raise cash and shore up balance sheets.
Companies have announced plans to raise about $510 billion via initial and secondary share offerings in 2020, up 50% from last year, according to data compiled by EPFR, a unit of Informa Financial Intelligence. For the first time since the 2009 crisis year, that matches the amount that companies announced they’d remove via buybacks and takeovers. For context, an average of $3 was bought back for every $1 raised over the past decade.
Corporate demand “is one component that drives the market higher that is no longer relevant” in this risk-on atmosphere, said Randy Frederick, vice president of trading and derivatives for the Schwab Center for Financial Research. “On its own, I would not say it makes the market go down, but it might cause the market to flatten out and not go much higher.”
For now, of course, there’s no sign the slowdown in buybacks is impeding price gains, when everyone from hedge funds to retail investors are chasing rallies that added a record $5 trillion to equity values in November. It’s also possible that positive vaccine news will usher in a reawakening for buybacks.
But the explosion in offerings is swelling the pool of stocks, a trend that has pressured share prices at market tops in the past. The S&P 1500 Index divisor, a rough gauge for outstanding shares, has risen 0.2% this year, poised for the first increase in 10 years, data compiled by Bloomberg show.
While the boom in IPOs underscores a robust market, higher share counts could also be viewed as an indication companies are “selling high,” with valuations too attractive to resist -- while being too rich to justify buybacks. At 22 times earnings, the S&P 500 trades near the highest multiple since the dot-com era.
“Obviously when the market is at an all-time high, you want to issue shares now, because the shares are worth a lot more than they would be if the market was tanking,” Winston Chua, an analyst with EPFR, said by phone. “Looking at the market broadly, companies are not being supportive of share prices.”
Despite record cash hoarding, some firms have shunned share repurchases with the pandemic surging anew. Others, like the biggest banks, are prevented by the Federal Reserve from returning cash to shareholders. Announced buybacks have dropped 54% to $390 billion this year, according to data compiled by Birinyi Associates.
“There’s a lack of an incremental buyer out there, so that’s a negative, and it still signals some caution as companies let the cash accumulate,” said Mike Bailey, director of research at FBB Capital Partners. “The flip side is, you are building more pressure for companies to really drop the hammer and start to buy back stock next year and into 2022.”
That’s a scenario that Goldman Sachs Group Inc.’s strategists led by David Kostin see coming. In 2021, net share repurchases will double to $300 billion and equity issuance will fall from this year’s record high, his team forecast.
Corporate actions on equities showed a close inverse relationship with the market’s performance. During the two decades through 2015, companies boosted net equity demand in 15 different years, 12 of which saw the S&P 500 gain, a study by EPFR showed. In the five years when corporate supply increased, the equity benchmark fell 60% of the time.
New listings on U.S. exchanges have raised more than $150 billion this year, with roughly half of that by special purpose acquisition companies, or SPACs, according to data compiled by Bloomberg. Airbnb Inc. just filed to sell as much as $2.6 billion for the home-rental platform and its existing investors to cap one of the busiest years ever. Other companies planning listings include food delivery service DoorDash Inc. and video-game company Roblox Corp.
“In every cycle, when we say, ‘OK, that was the deal the market rolled over on,’ and all of a sudden everyone’s pulled in their horns,” said Arthur Hogan, chief market strategist at National Securities Corp. “I don’t think we’re there yet, but certainly the number of deals has been pretty historic,” he added. “Companies that shouldn’t be coming out come out and there’s always a tipping point.