Companies issuing a ton of shares
Mark Hulbert, writing for MarketWatch, references some research indicating that companies have been issuing a ton of shares in the last few months:
There are a couple things to keep in mind when reading stuff like this. These numbers are not adjusted for inflation so a larger number now doesn't necessarily mean it is somehow worse (in this case, the issuance is probably high even in real terms but I'm just bringing this up as a general remark.) Secondly, history never repeats...it only rhymes ;)
It should be obvious why there are ton of shares being issued: bank re-capitalizations. There have also been some big capital raising by distressed companies and over-leveraged commodity businesses. The real question is whether it will continue or whether this is a one-off event. If the issuers, especially the financial companies, keep coming back to the market then it is very bearish. All the capital that flows into the market will be sucked up by them.
Even if it is a one-off time period, there are some negative consequences (but it's not clear how negative they are.) As Ned Davis suggests, the market rallied hard from late 1929 to early 1930 while companies were issuing shares, but ended up with a long decline that was even worse than the 1929 crash. However, one shouldn't blindly compare the present to the 1930's. The long decline after 1930 was due, primarily, to bank runs and a repeat will only occur if banks are inadequately capitalized right now. The US government, based on their analysis of stress tests, believe that banks are fine. I don't understand banking or accounting very well and my guess is that most financial institutions will be fine, as long as we don't end up with massive losses on non-residential real estate. That is, as long as losses from commercial real estate, credit card loans, and so on, are limited, a repeat of the 1930's with spectacular bank runs seem remote (even if losses are large, bank runs only seem likely in countries like Ireland, Britain, and the like, because the banks there are very large relative to the government whereas that's not really the case in America.)
It remains to be seen what the market thinks of all this share issuance. Future returns will be lowered when shares are issued—profit pie divided by more—but it depends how undervalued assets are.
In fact, firms have recently issued far more shares of their stock (either through initial public offerings or secondary offerings) than they did even in the go-go years of the late 1990s and at the top of the Internet bubble in early 2000....
Prior to May, according to TrimTabs Investment Research, the highest level of share issuance in a given month was $38 billion. May blew that record out of the water, with a monthly total of $64 billion.
Furthermore, that blistering pace has continued during the first two weeks of June, according to TrimTabs.
How bad an omen is this corporate eagerness to offer its shares to the investing public? Looking back through recent history, TrimTabs found that there have been just 12 months since 1998 in which total new corporate offerings totaled at least $30 billion. The average return for the S&P 500 index over the 90 days following those months was a loss of 4%....
The recent surge in the supply of shares has also caught the attention of Ned Davis, the eponymous head of Ned Davis Research. He has found through his research that it is optimal not to focus on monthly totals but instead on a rolling 13-week window. On this basis, according to Davis, recent corporate issuance has been exceeded historically only by two other occasions -- early 2000 and early 2008.
Those were "not great times to buy stocks," Davis notes dryly.
Davis also draws an even more ominous parallel to the recent corporate rush to sell stock: "This high level of [recent] supply is one of the key characteristics of the monster rally in November 1929 - April 1930."
There are a couple things to keep in mind when reading stuff like this. These numbers are not adjusted for inflation so a larger number now doesn't necessarily mean it is somehow worse (in this case, the issuance is probably high even in real terms but I'm just bringing this up as a general remark.) Secondly, history never repeats...it only rhymes ;)
It should be obvious why there are ton of shares being issued: bank re-capitalizations. There have also been some big capital raising by distressed companies and over-leveraged commodity businesses. The real question is whether it will continue or whether this is a one-off event. If the issuers, especially the financial companies, keep coming back to the market then it is very bearish. All the capital that flows into the market will be sucked up by them.
Even if it is a one-off time period, there are some negative consequences (but it's not clear how negative they are.) As Ned Davis suggests, the market rallied hard from late 1929 to early 1930 while companies were issuing shares, but ended up with a long decline that was even worse than the 1929 crash. However, one shouldn't blindly compare the present to the 1930's. The long decline after 1930 was due, primarily, to bank runs and a repeat will only occur if banks are inadequately capitalized right now. The US government, based on their analysis of stress tests, believe that banks are fine. I don't understand banking or accounting very well and my guess is that most financial institutions will be fine, as long as we don't end up with massive losses on non-residential real estate. That is, as long as losses from commercial real estate, credit card loans, and so on, are limited, a repeat of the 1930's with spectacular bank runs seem remote (even if losses are large, bank runs only seem likely in countries like Ireland, Britain, and the like, because the banks there are very large relative to the government whereas that's not really the case in America.)
It remains to be seen what the market thinks of all this share issuance. Future returns will be lowered when shares are issued—profit pie divided by more—but it depends how undervalued assets are.
But CRE looks like a disaster area and the real consumer recession is only just beginning. I must admit that I have recently gotten seriously bearish on the prospects of CRE and by implication on many financials. Also, Rortybomb has a DIY version of the stress test to see where the banks maybe are under various assumptions of unemployment. It isn't pretty. And that doesn't even mention the potential fallout from Southern and Eastern europe.
ReplyDelete(but I have a short bias at the moment so I may just be lawyering for my book)
I typed up a long message that seems to have been lost :( But anyway to repeat some stuff I was saying...
ReplyDeleteI think it depends on the region you are looking at. America and its banks look ok to me. I would not invest in them but I don't really know if a solid short case can be made, except possibly some select ones. Commercial real estate doesn't seem to have been overbuilt, except for some stuff like hotels (or anything in Las Vegas or stuff like that.) There will definitely be losses, including a lot by private equity who bought at the top, but it looks nothing like residential real estate.
One thing, though, is that if CRE blows up, regional banks may get hit a lot more. I this happens, we would, unfortunately, enter a totally new phase of this crisis. So far, the massive losses have been borne by megabanks (and some regionals) but if it spreads to regionals, it will be very painful.
The thing about American banks is that they may, as John Hampton and Warren Buffett have speculated, earn their way out. The same cannot be said for British, Irish, and other banks--hence the need to nationlize them.
I think your concern about Eastern Europe is quite valid. Europe looks very wobbly to me. If as as speculated in that Krugman interview I mentioned a few days ago is true (i.e. German banks possibly haven't realized losses yet) things could get ugly. Although Eastern Europe seems to be following the path of the Asian Tigers in the late 90's, it looks kind of small to me. I haven't looked into the detail, of either the economic size or the population or total credit or whatever, but they don't look anything like East Asia in the 90's. For example, Latvia has been making the news lately but it's sooo small. This doesn't mean that there won't be losses; all I'm saying is that the ECU, IMF, et al, can probably cushion the blow for the most part.
My concern with Europe isn't really the loan losses (either to Eastern Europe or to American homeowners, among others). Rather, my real concern is the structure of the economy in Europe. Spain, for example, seems "stuck" and unable to re-structure itself. Germany, in a different sense, has been way too export-oriented and they can easily suffer if foreign demand doesn't pick up. Referring back to the Krugman interview, Germany seems to be contracting at a more severe rate than Britain, America, or anyone else.
I suspect the future problems will be social problems, rather than anything financial per se. The banking system can stabilize but if unemployment is really high, things won't be pretty. On top of local political problems, with immigration, wages, layoffs, and the like, it could start trade wars and protectionism. No one is talking about this stuff and I hope it doesn't deteriorate much but I would be more concerned with this.
The problems that are rising in Europe start as social problems, then become financial problems. The core of the matter is that Spain, Italy and much of Eastern Europe need to devalue over 20% against Germany to regain competiveness. They cannot devalue the currency as they are in the euro or locked to it, the cannot let inflation erode real wages as Europe is in deflation. The only way is to impose massive direct pay cuts and hope this doesn't break the credit markets (good luck paying your mortgage if your pay just got cut 20%) and doesnt trigger a revolution (good luck on that one too...) That, or get out of the euro and devalue (after the revolution presumably). Either way, banks lose massively.
ReplyDeleteLatvia is small, but Spain and Italy are not and their problems are the same, worse actually because of much higher starting government debt. Meanwhile the authorities, the Germans in the lead, simply deny there is a problem and thus make things worse.
Spain has problems with employment, structure of the economy (way too dependent on contruction during the boom years), and so on, but it's fiscal position does not look bad. According to Wikipedia, Spain has a lower debt to GDP than France, Germany, Canada, and so on. Assuming these numbers are correct, it probably means Spain has more room to maneuver, at least when it comes to the government.
ReplyDeleteItaly is a different matter and its 100%+ debt-to-GDP limits their choices. I don't really know what is going to happen in Italy. They will face serious issues and it remains to be seen how they solve them.
I agree with you that de-valuation is not possible here. That is the easy solution but it's not the only necessary condition. Do note that, if I'm not mistaken, countries with weaker credits can issue debt at lower cost if they are part of the EU (I think the market still prices them differently but there is still an improvement as part of the EU.)
Monetary union limits options available to governments but I think it is benefitial in the long run. In some sense, USA has one currency but is made up of many little "countries". The economy of Oregon is very different from Florida, which is very distinct from Texas. EU is kind of like that now. The big difference, though, is that there is labour mobility within USA whereas EU doesn't; capital flow also isn't that great within Europe, whereas someone investing in a company or building a factory doesn't care whether it is in Kansas or Oregon. I think you guys can pull through--consider me pro-EU--but it won't be easy.
Anyway, it'll be interesting to see how the various problems are tackled. You are closer to ground zero so you'll probably get a better feel...