If a string of US bank failures and the near collapse of Credit Suisse were supposed to constitute a “last straw” moment for stocks which, more than a year into the second bear market of the 2020s, still haven’t suffered a proper crash, the memo got lost in the mail.
The Nasdaq 100 is coming off its best quarter in 11 years, and global equities rose in six of March’s last seven sessions to finish the month with a near 3% gain. That wiped away February’s losses, leaving January’s blockbuster rally as the effective “YTD” performance.
Bearish sentiment abounds, and travelers have passed so many yield curve recession signposts over the last 13 months they’ve lost count. But here we are, staring at a bear market which, frankly, doesn’t look much like a bear market if you’re measuring based purely on depth. Last year’s lows really weren’t that low in the context of historical bears.
Of course, cautious strategists insist profit forecasts are too high and Wall Street economists generally view some kind of downturn as inevitable even if preemptively calling for a deep recession isn’t something one does in an official capacity and/or in polite company.
In addition to the myriad well-publicized fundamentals-based bear narratives, it’s worth asking whether a simple lack of buyers might end up being a problem for stocks going forward.
This isn’t a straightforward discussion. Obviously, there’s a mountain of sideline cash which could, in theory, be deployed into equities should the fundamental backdrop improve. Cash levels are elevated (as are cash yields) and part and parcel of any good “squeeze”/”chase” is a force-in dynamic — underperformance angst is a factor when stocks run away higher. In that context, I’m not sure there’s a “shortage” of potential buyers, exactly.
On the other hand, the existence of viable alternatives to stocks (particularly “cash” as an asset class) may bleed household demand. Indeed, Goldman recently suggested households could sell as much as $1.1 trillion in equities in 2023, depending on the evolution of 10-year US Treasury yields and the savings rate.
So far, there’s been no capitulation on the flows side thanks entirely to emerging market equity funds, which just enjoyed one of the largest quarterly hauls of the past half-decade. But developed markets are another story entirely. DM-focused stock funds lost nearly $22 billion during Q1, thanks to a veritable exodus from US equities.
US ETFs and mutual funds bled more than $6 billion over the latest weekly reporting period, taking YTD outflows to more than $47 billion.
The usually reliable corporate bid isn’t a guarantee either. The 12-month percentage decline in cash balances among S&P 500 companies was the largest on record in 2022, as management teams funded spending activity with cash on hand to avoid raising their cost of debt.
Buybacks plunged 21% in Q4, and although authorizations are still robust, executions less so. According Goldman’s buyback desk, authorizations were running 11% above 2022’s pace as of late last month, but “actual flow activity [was] running substantially lower than last year’s YTD volumes.”
For the full year, Goldman expects $350 billion in net corporate demand, down nearly half from 2022. If equity issuance picks up later this year, net demand could be materially lower. And all of that’s to say nothing of the political climate, which isn’t exactly buyback-friendly.
Meanwhile, retail investors aren’t as excited as they were in January, when stocks galloped out of the gate as the calendar flipped.
Although retail bought a record amount of US shares in February on net, buying has since “fallen sharply,” The Wall Street Journal reported over the weekend, citing data from Vanda Research. “Individual investors are losing their appetite, leaving equity markets without a dependable leg of support,” the Journal said.
Ultimately, ironically and self-evidently, a lot depends on how stocks perform. NIRP, ZIRP, LSAP and TINA are dead. Inflation buried them. But human greed will never die, which means one acronym is immortal: FOMO.
Nobody should blame the fall in buybacks on rates. There are some really smart people serving as CFOs of our major companies, so they should know that there is no actual bottom line return that arises from buying back one’s own stock, even if they are loathe to admit this knowledge. Further, when bought with borrowed capital at inflated prices, the use of shareholder capital in this way results in an opportunity loss, unlikely to be recovered … a reason I don’t buy stocks. Also, to assume that firms are not borrowing money to buy back their own stock proves they know what a bad bargain is struck with such financial engineering. These highly smart people also don’t seem to remember their basic MBA corporate finance course very well because if they did, they would know that the use of a firm’s assets, even for CAPEX, involves incurring a cost of equity capital. If these highly smart people hadn’t wasted so much of their debt capacity buying back their stock, with no return to the bottom line, they would awaken to the fact that the cost of equity capital (you, know, one’s own funds) is always higher than the cost of debt, so even though these folks should know better, if they could borrow for CAPEX, etc., it would still be cheaper than using internal equity. The thing is, even MBAs from HBS don’t tend to pay attention to the cost of equity (it is after all, largely an opportunity cost) because it is seemingly a non-cash expense, unlike interest, so they always tend to think equity capital has no cost, these ultra-high thinking (bad) decision makers. BTW, this was the subject of my masters thesis back in the day. Got a nice grade on that one.