Stock market bulls are needlessly worrying about the recent record pace of new stock issuance. In fact, when viewed properly, the current pace of stock issuance is actually neutral for the stock market — if not slightly bullish.
In other words, what appears to some to be a sign of a bubble about to burst may actually mean something closer to its opposite.
Let’s start with the numbers. According to the Federal Reserve, new stock issuance has totaled $582 billion over the past four quarters from non-financial U.S. corporations. That’s far and away a record. The previous record came at the top of the late 1990s’ internet bubble, when the comparable total was $354 billion. The recent pace is more than 60% higher than the pace then.
Merely matching records set at the top of the internet bubble would be scary enough, much less breaking those records by 60%. And it makes sense that high levels of stock issuance would be bearish: companies have a better sense than the rest of us when their shares are overvalued, so it’s a warning sign when they are eagerly issuing new shares.
The reason record share issuance may not actually be bearish is that there has been a heavy volume of stock buybacks (or repurchases), as well as of mergers and acquisitions. Each of these other activities represents the opposite of new stock issuance, since they reduce the number of shares outstanding. Record stock issuance is not necessarily bearish if it is accompanied by high levels of buybacks or M&A activity.
That means we need to focus on net, rather than gross, issuance. When we do that, a far different picture emerges. In fact, according to data from the Federal Reserve through the first quarter of 2021, as well as more recent data from TrimTabs, net issuance for non-financial corporations is negative — just as it’s been for many years now. That means that non-financial corporations on balance are retiring more shares than they are issuing.
The recent chart plots the Federal Reserve data. Notice that the last time there was positive net issuance was in early 2009, at the bottom of the bear market that accompanied the Global Financial Crisis. These two series came close to being in balance during the economic lockdown a year ago, but that was short lived and net issuance is now back solidly in negative territory.
Is it a good sign for equities that net issuance is negative? Perhaps, according to a 2018 study in the Financial Analysts Journal entitled “Net Buybacks and the Seven Dwarfs.” The authors of that study found that net issuance explains the bulk of the difference in different countries’ stock returns over the last several decades.
Note carefully that the authors didn’t investigate whether net issuance has any explanatory power for the short term. To help fill in that gap, I measured the correlation between net issuance and the S&P 500’s subsequent total real return. I focused on issuance over periods as short as the trailing quarter to as long as the trailing three years, and on the S&P 500’s subsequent return over periods as short as one quarter and as long as three years. My database covered all years since 1988.
I came up empty in my search for statistically significant correlations, regardless of the length of the periods measured.
The conclusion I draw: It would be going too far to interpret recent net issuance trends as outright bullish for the stock market’s prospects. But the bulls at least can take some solace in knowing that the share issuance data are not screaming that a bubble is about to burst.
Let me hasten to add that the stock market may nevertheless be forming a bubble. Net issuance is not the only indicator out there, needless to say. The point of this column is that share issuance is not an additional reason, above and beyond others, for believing that such a bubble is forming. But it is curious that some of those who believe a bubble is forming are relying on an argument that is so obviously misleading.