For The First Time In A Decade, The US Stock Market Is Expanding

From April on, the pandemic forced Wall Street analysts to toss out the playbook on pretty much everything.

And that was actually fine, because let’s face it, that playbook is wrong at least as often as it is right anyway.

In that sense, forecasting during the pandemic was a lot like forecasting in any other year: Just a drunken game of blindfolded darts, only this time, everyone was drinking Everclear instead of Sam Adams.

As it turns out, though, Wall Street was arguably more prescient than quite a few “brand name” luminaries, many of whom missed the boat completely on the rebound in equities (and credit) from the March lows.

For example, Paul Tudor Jones ate “humble pie.” Jeremy Grantham was incredulous. Howard Marks penned a dizzying array of increasingly incoherent missives which culminated in an attempt at philosophical profundity so laughable that I stopped reading his memos for the first time in my life.

Then there was Stan Druckenmiller, who in May boldly proclaimed that “the risk-reward for equity is maybe as bad as I’ve seen it in my career,” before admitting two months later to having only managed a 3% gain during a 40% rally. (As of September, Stan still insisted stocks were a bubble, calling equities an “absolute raging mania.”)

And don’t forget about Warren Buffett, who incurred a mind-boggling $50 billion paper loss during the first quarter and then proceeded to just buy back his own shares, apparently for lack of better ideas.

I won’t even mention Jeff Gundlach (oops, I just did) or any of the other “usual suspects” who, even outside of an actual crisis, perpetually insist that something or other is “unsustainable” and will invariably lead us all to ruin, if not to the edge of the River Styx itself. (Bring a coin — Charon doesn’t work for free, you know.)

Anyway, in addition to recalibrating revenue and profit forecasts to account for the possibility that, for many businesses, there would be no revenue or profits, sellside analysts also needed to account for the prospect of plunging buybacks and a deluge of equity offerings, as panicked corporate management teams cut spending and looked to raise cash.

In simple terms, the pandemic turned the equity supply/demand picture upside down. For example, over the summer, Goldman projected buybacks would dive by ~50% in the US in 2020.

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

While a wave of secondaries needn’t have been the end of the world, when coupled with falling demand, market participants were staring at a self-evidently bearish recipe: All else equal, when supply outstrips demand, prices fall.

Fast forward six months, and buybacks did, in fact crater, while IPOs and secondaries combined to make 2020 the first year in a decade that share offerings summed to an amount on par with shares removed in corporate activity, whether repurchases or takeovers. Indeed, the S&P 1500’s divisor is up this year for the first time since 2009 on Bloomberg’s data.

Back in May, while discussing this dynamic, I wrote that “the larger the collapse in earnings expectations against a rising market, the more stratospheric the forward multiple.”

Well, stocks are up since then (maybe you noticed) and while the earnings collapse hasn’t been as bad as feared, multiples are, indeed, stratospheric.

In the same linked post from May, I wrote that “the further stocks run, the more tempting it will be for corporates to issue equity, especially if ongoing headlines around bankruptcies and defaults prompt credit markets to extract terms commensurate with the risk.”

I was only half right. Credit markets have been the opposite of stingy. Both investment grade and junk yields are at all-time lows and issuance shattered records in 2020. But it does seem as though elevated stock prices have prompted companies to take advantage of the situation by tapping equity investors, while shying away from buying back shares at dot-com valuations, despite full coffers from debt sales.

This could bode well for 2021 if you’re a glass half-full guy/gal. Obviously, slumping buybacks haven’t been an impediment for equities in 2020. Next year, when the macro outlook is expected to improve, corporate management teams could start deploying cash and buying back shares again, especially if vaccine rollout goes smoothly, bolstering developing economies and helping the world get back to normal.

After all, what good is $2 trillion in borrowed money if you can’t plow it back into EPS-inflating buybacks?