http://www.nytimes.com/2010/09/07/business/07ipo.html?scp=6&sq=&st=nyt
The backlog of IPOs is a negative for the stock market in the near term, as a potential surge in supply of any commodity will serve as a weight on the price of that commodity. Offsetting the increased supply of stock from IPOs, however, is the harder-to-quantify reduction in supply of stocks that occurs when companies repurchase their own stock. We know that companies are very actively buying back shares, but it is difficult to know to what extent. Certainly, with lots of cash, limited investment opportunities and depressed stock prices, stock repurchases make a lot of sense. I believe that even a small rise in demand for equities (there is a huge amount of money parked in fixed income securities, and even gold, that will eventually find its way back into the stock market), we will see a quick and substantial rise in stock prices, and the backlog of IPOs should be absorbed quite easily. As for when that rise in demand will begin, it's anybody's guess; however, I would bet that, in the next three months, we will see investors starting to come back into the stock market. Watch equity mutual fund flows for signs of this return!
Also, all it will take is a few hot IPOs to get the market back in favor of them. After reading your post, I tried to quantify overall supply of stock by searching for a total number of shares outstanding on the NYSE and NASDAQ, but no such luck (only turnover rates). If someone can find this total we can create a very interesting model for effects on demand of IPOs based on relative supply of stock.
ReplyDeleteI'd like to question how much of an effect companies buying back their own stocks can have to increase the overall demand in the stock market. It would seem to me that the volatility in the market over the past 18 months, as the article mentioned, would have a greater impact on investment decisions than the rise in prices of a few already-public companies.
ReplyDeleteThe article also mentioned that many of the companies that filed for an IPO have already established themselves as viable investments. If they are fairing reasonable well right now, then shouldn't the demand for those stocks in particular would be higher than the market average?
"I'd like to question how much of an effect companies buying back their own stocks can have to increase the overall demand in the stock market."
ReplyDeleteBuybacks don't directly affect demand; they cause a reduction in supply, which with constant demand would cause an increase in price. Buybacks can indirectly affect demand by increasing investor confidence.
Josh is probably correct in questioning whether changes in total supply of stock is going to be a short term market-moving factor in the midst of much greater economic forces. However, longer term this will play a role in pricing whether it is recognized as the driver or not.
I would like to offer a supporting visual for Prof. Elliott's post:
(numbers are not accurate, just illustrative)
Total shares on the market: 1,000B
Shares added from IPOs: 20B
Shares subtracted by buybacks: (10B)
New total shares: 1,010B
Unfortunately I cannot draw in a supply & demand graph in a comment, but if I could it would show buybacks partially offsetting IPOs in terms of supply, and the demand curve shifting to the right as investors increase their allocation to stocks from other asset classes. In agreement with Prof. Elliott's thesis, this shift in demand will cause the new equilibrium point to be at a higher price.
I would like to take this notion a step further, now that we are thinking from a supply and demand perspective. It is taught in economics that when the demand curve shifts the supply curve tends to shift in reaction. Getting back to the example, this means that if prices of stocks are driven higher by an increase in demand, more companies will want to supply stock (meaning IPO) to get in on this higher price action. Without writing a 10 page essay about why (which I might do at a later time), trust me that there will be a very high probability of the increase in supply overshooting the increase in demand. Specifically, if stocks start fetching higher prices due to an influx of funds into the stock market, more and more companies will do IPOs until the supply of new shares from IPOs outstrips the demand for them. This contributes to the inevitable cyclical nature of the stock market.
To answer Josh's last question, yes - ceteris paribus (all things being equal), the IPO of a higher than average quality company should be met with greater than average demand, leading to higher than average prices of its stock. But all things are rarely equal.
Thanks for your comment, that cleared something up for me.
ReplyDeleteI do think that I was not as clear as I could have been in my comment. What I'd like to know is why you would create a supply/demand graph for 'the stock market' as a whole. It would be reasonable to me to make a s/d graph for, say, a sector or industry, but not the entire stock market.
How about a hypothetical example:
A technology company A goes public, and sells 500,000 shares. A few months later, a transportation company B also goes public, and sells 500,000 shares. The stocks of A and B seem to me to be substitutes, and not the same product that can be lumped together in one s/d graph. If, as an investor, I'm looking to invest in the transportation sector, why would I pay any attention to the A's price & quantity of shares (assuming the technology wasn't transportation-related in any way)?
Josh-
ReplyDeleteYou raise a very good question. In your example, you probably wouldn't be paying attention to anything about company A if what you want is something in company B's sector; just like you said. However, you must remember that although there are many different types of companies with public stock that have completely different and uncorrelated businesses, they are already 'lumped together' into the asset class of 'stocks'. It helps to think of this from a big money perspective. Institutional investors (which will be covered at the third seminar), such as pension funds, hedge funds, sovereign wealth funds, etc.. don't think in terms of individual stocks (usually), or even in terms of individual stock market sectors. When they decide on the allocation of their portfolios they decide among asset classes. For instance, instead of picking individual stocks, they will decide on 40% U.S. equities (stocks), 30% fixed income (bonds), 10% non-U.S. equities, and 20% alternative investments (hedge funds, private equity, real estate). If you look at it from this perspective, you can see why it could be helpful to track the supply and demand of the entire stock market. Again, we will go over institutional investors in the third seminar, which will further elaborate on what I just said, but you are bringing up great points and I would be happy to continue discussing this on this thread.