When it comes to equities, we know where the demand will come from. Or at least we think we do.
There’s households, for example. They’re rich now. I mean, not really. But that’s what you’d be inclined to believe based on the ubiquitous “excess savings” narrative which, in the pandemic era, is compelled to do double duty, supporting many a generic bull case for stocks as well as justifying the sunny outlook for consumption in the face of elevated inflation expectations.
I think it’s important to emphasize that cash sitting idle in money market funds (i.e., “sideline cash” just waiting to be deployed into stocks at the first sign of a dip) isn’t the same as whatever “spare” money is left over in checking accounts from various stimulus initiatives. Notwithstanding apps and opt-in programs that let consumers “round up” everyday purchases to buy fractional shares of stocks, I think it’s a mistake to equate “surpluses” in checking accounts with cash in money market funds.
In any event, other than households, there’s the corporate bid. “In an earnings season with many surprises – including the highest frequency of EPS beats in our 22-year data history – one of the most notable was the surge in corporate buyback activity,” Goldman’s David Kostin wrote, in a Friday evening note.
So far, he went on to say, Russell 3000 constituents accounting for 85% of 2019 buybacks have reported repurchase data for Q2. Between them, gross buybacks were nearly $210 billion, up 122% versus Q2 of 2020. Of course, that comp is meaningless. Corporates were hardly in the mood to burn cash during the pandemic lockdowns, not even on buybacks, that most “virtuous” of all cash deployment options. More notable is that the same figure represented a 27% increase from the second quarter of 2019.
Ok, but whatever, right? Who cares? I’ve been over this a thousand times. Well, the point is to juxtapose buybacks with projected equity supply, hence the allusion to “where the demand will come from” (above). But not just any supply. Rather, the supply associated with what Kostin aptly described as “the surge of equity issuance earlier this year.” Simply put, the lock-ups are set to start expiring.
The figures (below), from Goldman, illustrate the potential “problem.”
On the bank’s estimates, more than $150 billion of insider shares will come out of lock-ups over the next five months. More than $110 billion of that is in stocks that traded above their IPO price as of last week. In addition, Kostin suggested another $127 billion in supply could come from lock-ups expiring on follow-on issuance.
That sounds like a daunting wave to absorb, but it might surprise you to learn (or maybe it won’t) that Russell 3000 buybacks easily exceeded the combined supply from IPOs, SPACs follow-ons and convertibles over the first half.
When you toss in cash spent on public M&A, net equity demand was actually positive to the tune of a quarter-trillion in the first half. Indeed (and this is actually pretty incredible), Kostin noted that “even during Q1 2021, the largest quarter for equity issuance on record, net corporate equity demand was still positive.”
So, what about the second half? Well, the good news is that between already-announced new deals and what Goldman expects to be an additional $460 billion in buybacks, demand will outstrip supply again. As Kostin put it, the combined total of M&A demand and repurchases “would easily outweigh equity issuance in H2 even if issuance were to return to its elevated pace of Q1 2021 and all of the lock-up expiries were to result in selling.”
Of course, all of the lock-up expiries won’t result in selling. And even if they did, where do you think the proceeds would go? Hint: Likely into other stocks.
Thanks for the timely update!