By Charles Biderman
The US stock market seems to me very similar to the market in January 2000. Starting in mid 1999 I became convinced the market had to crash, but was getting extremely frustrated. I am attaching at the end what I wrote in the December 27, 1999 issue of what was then called Liquidity TrimTabs.
In essence what I said back then, and what I am saying now is that bull markets end for one reason and one reason only: when the supply of shares exceeds the demand. Back then everybody was is in love with the Internet tech stocks. That is, until insider unlocking and option conversion share sales overwhelmed the bulls, and beginning in April, 2000, the market finally headed south.
This go around, the sole source of new cash responsible for higher stock prices, is the result of the overall net reduction in shares outstanding; as buybacks have outdistanced all new share sales. As I have said many times before, companies are shrinking the total numbers of shares outstanding because of the zero interest rate environment combined with an economy experiencing virtually no growth in final demand. Why build a new plant or start a new project and incur any kind of risk when buying back shares hikes stock prices with no risk.
Back in 2000 internet stocks were it. At the Santa Rosa gym I used to go all the TV monitors were tuned to CNBC. At that time at the gym I was asked almost daily what they should do with their Nasdaq cuties, I said sell all, and if not all at least half. And guess what, virtually no one did. But they were truly sorry later.
That is the way it feels today. Except this time individuals are not buying; it is the so-called stock market professionals who are buying stocks. Individuals are buying bonds hand over fist mostly for yield. Stock market professionals managing the $15 trillion or so of institutional money in US equities have been trained that as long as the Fed is creating $80 billion a month stocks cannot go down. Therefore, fully invested is the only way to go.
The Bernanke Put is dead. Interest rates are not going below zero. Unless of course someone is using Fed money to directly buy equities, supply and demand says that float shrink has been and still is the sole source of new cash. But TrimTabs data shows that the rate of float shrink itself was shrinking during Q4 of last year while insider selling has been at near term highs.
As I reported earlier, withheld income and employment taxes spiked 15.5% the 12 days from mid December through year end that includes January 2. January 2 is included because that day taxes had to have been withheld from wages and salaries paid December 31 or before. It is still too soon to determine the impact of all that front running on this January's wages and salaries.
Why I am going on about how much income was pushed into 2012 to avoid higher taxes, is that when comparative corporate cash flow begins to weaken sometime this current quarter, corporate buybacks will stop and likely turn into net corporate selling. Will the float shrink of the past two and a half years stop? I say it has to since final demand will slump from very modest growth to an actual decline.
December 27, 1999
Is The End Of The Five Year Bull Market in Sight?
Historically bull markets end for one reason and one reason only: the supply of shares exceeds the demand. Liquidity analysis is the only way we know to determine when a bull market will end.
Liquidity is bullish right now. But that will change starting with the new year.
There are two aspects to stock market liquidity analysis. One is the change in the trading float of shares and second is the cash available to buy those shares. Both the float and available cash are very bullish right now, but are likely to turn bearish starting this coming February.
The first onslaught on the trading float will be the resumption of big time insider selling after year end. Insider selling slows in December for obvious tax reasons, but then bursts out of the gate big time in January. We have been estimating that insiders in 2000 will be selling monthly about $30 billion of converted options and direct holdings of never before sold shares. That data is based upon analyzing option conversion data from the top 30 US market caps and #144 insider selling. Our estimate for 1999 was $230 billion of total insider selling, or just under $20 billion monthly, up from $150 billion in 1998 and $100 billion in 1997.
The second way the float grows is when companies sell new shares - whether as an IPO, secondary or via convertible preferreds or convertible bonds. Starting the week of January 10 the new offering calendar will resume and during the second half of January perhaps $10-$15 billion of newly minted shares will be sold. However, by February the calendar should again total the $8+ billion weekly pace set this past November - after backing out Thanksgiving week - or $30+ billion monthly. $30 billion of insider selling plus $30 billion of new offerings equals a whopping $60 billion monthly of new shares being added to the float.
Trading Float Shrunk Between 1995 and mid 1999
Prior to mid 1999 the trading float shrunk continuously from the end of 1994. Cash takeovers of public companies and stock buybacks are the two methods for shrinking the float. New cash takeovers topped $230 billion in 1999, although $160 billion of those deals, $20 billion per month, were announced during the first half of this year - which was in response to the huge market sell off late 1998. During the second half of this year, new cash takeovers were cut in half, averaging just $10 billion monthly. That $10 billion per month pace, or $120 billion for the year, seems logical to expect for 2000. Stock buyback announcements have averaged about $180 billion each of the past three years. Since our assumption is that 90% of announced buybacks get done, that translates to $160 billion annually, or $13 billion monthly.
$10 billion of cash takeovers plus $13 billion of stock buybacks equals $23 billion of float shrink monthly.
Therefore, starting in February the float could grow each month by $60 billion - $23 billion, or $37 billion.
Where Will the More Than $37 Billion of New Cash Come From To Stop A Market Collapse?
Where will that $37 billion monthly come from? Even if $37 billion were found, that would not take care of the normal selling done by individuals for personal reasons each and every day the market is open. Under maximum conditions, individuals could provide perhaps $20 billion monthly and foreigners $10 billion.
The Federal Reserve says that foreigners have bought monthly an average $9 billion of US equities during the first nine months of 1999. Maybe they can go to $10 billion monthly next year, but remember their markets have been doing better than ours lately, plus a huge amount of new offerings are scheduled offshore as well.
Individuals can't buy much more than $20 billion of US funds and direct shares each month. Why? Adjusted Gross Income is about $6 trillion per year. Add $15 monthly billion into US equity funds plus $2 billion into global funds - that doesn't go to buying US stocks - and $5 billion direct; all that equals $22 billion monthly or $264 billion. That's 4.4% of AGI, which is a lot, and probably too high in reality.
Margin Debt Is Usually The last Source of Cash At The End Of A Bull Run
Nobody wants to bet against this stock market. We have had many conversations over the last two weeks with seasoned market professionals and not one really thinks this could be the end of the line. Not because they have an answer as to where the necessary new cash will come from; but simply because this market has continued to go up defying all conventional logic - except for liquidity theory - and during the past five years fresh cash has always shown up to continue to lift the market cap higher.
We agree that this market has surprised us many a time since 1995. However, the float continued to shrink each month so that the new cash flows were competing for a diminishing trading float. Perhaps there is some new source of cash that will save the day next year as well. Insiders could decide not to sell as much and the new offering calendar could stop at $10 billion monthly. Cash takeovers and stock buybacks could surge.
But we doubt that will happen unless stock prices drop at least 10% from current levels.
The only other source of fresh cash is debt. Margin debt popped $24 billion in November. That is the only way the $34.5 billion of new offerings sold that month could have been absorbed and allowed the market cap to still rise 3.2%. Our guess is that December's margin debt growth will also soar about $24 billion, if not more. A December spike in margin debt of $24 billion would mean margin debt grew by $90 billion in 1999, or 63%. If the market ends 1999 at $17.5 trillion, that will be a gain of 28%. The last time margin debt rose that much faster than the overall market was in 1993 - right before the market dropped for the year as a whole.