Shrinking market to drive stock prices up?

[REWahoo]

Here's a take on the US equity market that I've not considered:

U.S. stock market shrinks by $600 billion - Fueled by LBOs and buybacks, contraction may bode well for 2007

"If the supply of equities continues to dwindle and retail investors also rediscover their former penchant for U.S. stock mutual funds, it could mean the market in 2007 would get a significant push higher, some strategists said."

A reasonable theory...or deadline journalism during a slow holiday week?

 

[CCdaCE]

Finally, Large Caps will again have their day!

That means shares outstanding in the U.S. contracted by at least $600 billion this year -- roughly 3.1% of the market's total value, according to TrimTabs.

So, does that drive up the market price by about 3% or am I drawing incorrect parallels?

I'd also assume this price change has already taken place or, takes place as the shares are "taken off the market". Assuming a perfect supply & demand curve (inelastic?, elastic?, I forget - too lazy to look it up, etc.). Nothing says they can't be reintroduced to the market (new shares issued, etc.) or sold by the takeover company. No?

"When the dumb money starts buying heavily it's the end of the game," said Charles Biderman, chief executive of TrimTabs. "But right now it's still the smart money buying."

Setting ourselves up for a big crash are we? ...whoever Biderman is.

"To draw too many conclusions from this is tricky," Vadim Zlotnikov said in an interview.

I think he has it right.

-CC

 

[audreyh1]

Cramer at thestreet.com has been talking about this phenomenon for quite a while. More about how companies have been aggressively buying back their own stock over the past year. IMO this does bode well for the stock market by boosting earnings per share.

Audrey

 

[d]

this also suggests that companies believe their market price to be undervalued ... assuming they're correct, another good sign.

 

[JJac]

By the same logic, when a company IPOs does it push the market down? Google is current valued at ~142 billion dollars, but 2.5 years ago as a private company it was worth zero?

 

[dmpi]

US companies are flush with cash, they got to use the money somewhere.
If you look at US large cap mutal funds, investors have been net sellers all year long.
What this means is there is little downside risk because investors can't sell out because they never bought it.

The investors will buy in again... but not before we are 40% higher.

 

[audreyh1]

US companies are flush with cash, they got to use the money somewhere.

Yes, this is the biggest reason for the buying of stock. But it does shrink supply!

And one thing seriously limiting IPOs (and thus supply) these days is the cost of Sarbanes/Oxley type paperwork. The burden is quite large for small companies - a major hurdle. It's another reason why some of the smaller companies are motivated to be taken private again.

Companies are also less inclined to grant stock options for lots of reasons - new accounting being one. So during the 90s the stock market was flooded with new issues due to options as well as IPOs. This appears to be much less the case today.

Audrey

 

[wabmester]

I've always liked Bernstein's paper:

The Two-Percent Dilution

He argues that stock prices track GDP growth less around 2% dilution from secondary offerings and stock options.

It looks like for the past couple of years, buybacks have more than offset this dilution. Cool. Unfortuantely, GDP growth has slowed to 2% real.

So, if you believe Bernstein, fundamental stock growth for last year is something like 2% GDP + 2% inflation + 3% for buybacks = 7%.

But the market has gone up 14%. Does that mean that 7% of that market growth is speculative and we'll have to give it back pretty soon?