The Shrinking Market

 The availability of stocks in the US has been shrinking this year, explaining some of the strength of market gains. In January, Business Week noted that in 2011, companies bought back $397 billion in company equity while issuing only $196 billion of new shares. The trend seems to be continuing in 2012, in spite of a very high profile Facebook IPO in May. 

The laws of supply and demand apply to stock and bond returns just as you learned in Econ 101. If new stock shares flood a market, there may be more sellers than buyers. Conversely, if the supply of stock declines, it may help to boost the returns of remaining stocks. 

Stock supply can be controlled by decisions made by companies. In order to raise money, companies may borrow from bond markets or banks. An alternative is to issue new stock and potentially dilute the ownership of existing shareholders. If companies happen to have stockpiles of cash, they may choose to pile up the cash, pay-off debt, establish or increase dividends, or buy back stock. 

Today, you have a borrowing environment with extraordinarily low interest rates. This makes the decision to issue debt easier to swallow for companies with good credit. You also see record corporate profitability and many large companies have built a war chest of cash irrespective of borrowing. There are other ways the outstanding shares can shrink, like mergers and acquisitions. 

For personal investors, fewer shares may mean the potential for stronger returns with investments. It's important to keep in mind, though, that valuation matters and a shrinking stock market may result in higher than appropriate prices. Today we especially note the potential for the shrinking supply of stocks to offset the lack of enthusiasm for stocks and bond favoritism, quietly keeping more balance in markets than headlines about bond flows would indicate.

 

The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete.  Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Any opinions are those of Center for Financial Planning, Inc., and not necessarily those of RJFS or Raymond James.