Goldman: Corporate Demand For US Stocks ‘Will Plummet 80%’ This Year. S&P Ain’t Going Anywhere

During the first quarter of 2020, the aggregate equity allocation of households (a category which includes hedge funds), mutual funds, pensions, and foreign investors, dropped precipitously (six percentage points) to 40%, Goldman writes, in a note updating their forecasts for US equity supply and demand. Those categories together control 86% of the US stock market.

Since then, the bank reckons that between the strong bounce in stocks, the well-documented uptick in retail trading activity, and recent equity fund inflows, allocations are almost back to pre-COVID levels.

On Goldman’s estimates, which take into account price changes and fund flows, aggregate equity allocation now sits near 44%, in the 80th percentile historically.

Somewhat contrary to the prevailing narrative which says light positioning could fuel further upside as systematic funds re-leverage into subdued volatility and discretionary investors become more comfortable with a rally that left them behind, Goldman says “incremental net equity demand represents only a modest upside risk to share prices in the near term”.

While the bank’s David Kostin acknowledges that “some additional room exists for equity allocations to rise” if cash allocations were to fall to pre-crisis levels, fears of a second virus wave and election jitters “will limit a significant increase in equity exposures”.

Recall the discussion from “Why A Massive Debt-To-Equity Swap May Be Coming“. I’ll recap using some of the language from that post.

Buybacks are expected to collapse in 2020, for obvious reasons (companies are looking to raise cash, not spend it, due to the crisis).

The corporate bid has, of course, been the single-largest source of US equity demand for years, so it’s somewhat disconcerting that it would dry up, especially when the macro outlook is the worst it’s been in at least a century.

Consider that against what many believe is a coming deluge of equity issuance.

Secondary offerings are already showing up from distressed entities (indeed, Hertz tried to sell stock in bankruptcy last week), and while a wave of secondaries doesn’t have to be the end of the world, falling demand (in this case a possible 50% reduction in buybacks) and rising supply (XYZ billions in public equity sales) is a self-evidently bearish recipe — all else equal, when supply outstrips demand, prices must fall.

Well, Goldman’s David Kostin is sticking with the bank’s forecast for gross buybacks to plunge by 50% this year, thanks mostly to a 33% drop in earnings. “So far, around 100 S&P 500 firms representing 45% of 2019 buybacks have suspended buybacks this year, and YTD authorizations are down 49% year/year”, he writes.

But, to the points above, Goldman is also looking for some $300 billion in US equity issuance, the most in at least two decades. Here’s some additional color from Kostin:

Equity issuance has skyrocketed to $170 billion YTD (vs. an annual average of $230 billion since 2009) as companies scrambled to raise cash during the economic shutdown. So far in 2Q, issuance has totaled $130 billion, which is already the highest quarterly issuance in 20 years. In 2H, we expect issuance will slow from its current pace but remain at above average levels. On one hand, the low interest rate environment will likely continue to support debt financing, which has also surged in recent months with $1.2 trillion of IG credit issuance and $184 billion of HY issuance YTD. On the other hand, many companies will take advantage of elevated equity prices to recapitalize and strengthen their balance sheets.

So, even as the Fed managed to pry open the doors to the debt market, precipitating more investment grade issuance in the first six months of 2020 than all of 2019, companies will still turn to equity markets to raise capital.

Ironically, rallies could be just the motivation cash-strapped companies need to sell shares, and the temptation could be amplified if debt markets were to become unforgiving again.

On net, Goldman sees just ~$100 billion in demand from corporates for the year, a dramatic decline from previous years, when buybacks supported equity prices.

Pension funds and mutual funds will remain net sellers, the bank writes, adding that foreign investors should be net buyers, especially if the dollar weakens, although elevated allocations could cap demand.

As for households, Goldman expects 2020 to be a banner year. They cite recent retail activity. “Broker data show a surge in retail equity trading activity, and a basket of retail favorites has outperformed both hedge fund and mutual fund favorite positions since the March 23 low”, Kostin reminds you, recapping from last week.

And yet, how households behave vis-à-vis stocks will depend heavily on sentiment around the virus and the election, something the bank readily acknowledges.

“Perhaps even more than for other investor types, the pace of viral spread and path of economic normalization will be key determinants of household equity flows”, Goldman says. “In addition, political uncertainty, particularly regarding personal tax rates, represents a risk to our forecast”.

Ultimately, Kostin cautions that “periods of elevated policy uncertainty have generally coincided with lower-than-average equity allocations during the past 30 years”.

Goldman is sticking with its year-end target of 3,000 for the S&P, leaving the market rangebound (2750-3200) for the remainder of 2020.