Honey, I Shrunk the Equity Supply

Catching up with a few factoids on the incredible shrinking equity supply on major markets.

  • The supply of stocks shrank by $604-billion in 2006, a record
  • In first four months of 2007 it fell by another $300-billion, which is 1.4% or 4.3% annualized
  • More than $1-trillion of equity supply disappeared via buyouts and M&A in 2005/06

More here, here, and here.


  1. And, according to Jim Jubak, its all thanks to the “availability of easy money distorts calculations that are used to determine whether stocks are overvalued or undervalued and makes the markets hard to read.”

  2. Paul, I read this article at SFGate and the one on Sunday and both times my BS detector starting to ring. There might be some (slight) causal relationship between float and pricing levels, but this article certainly didn’t convince me one exists. The M&A/going private/stock buyback thesis is a red herring. Does the combined value of two companies change when they merge? No. No change in liquidity/float there. What about cash transactions? Nope, bought out stock holders will simply purchase a different equity. What about going private? Nope. Where does the cash from that transaction come from? A private equity hedge fund. And where to you suppose their Limiteds get their funds? Change their asset allocation from public to private. That asset allocation changes the demand side by the exact same dollar value. Also, they didn’t mention that some stock buy backs are to cover exercise of ISOs and the buybacks are simply an anti-dilutive measure.
    I’m sure there is relationship between money supply and foreign investment, current account, etc. and pricing levels, but not float. Anyone that’s tried to sell a thinly traded stock knows that the float will impact liquidity, but that’s going to show up in the spread, not the price.

  3. franklin stubbs says:

    One could argue that, because shrinking equity supply is a function of expanding debt, it is not a bullish factor in and of itself. (After all, that’s what these studies are meant to imply right? That equity shrinkage is bullish?) Rather, it is just another offshoot of an overgenerous credit cycle.
    To wit: if the total equity supply is shrinking because PE guys are buying public companies left and right, then equity is being converted into debt (as PE guys leverage up the balance sheets).
    As more companies become takeover bait, valuations in general are lifted via investor optimism (this has already happened). Debt and leverage are the fuel that maintain and sustain this optimism.
    But here’s the rub: it takes generous financing terms and plenty of liquidity for the game to continue… and as valuations become more and more excessive, at some point gravity kicks in.
    Conclusion? Shrinking equity supply is not a standalone bullish factor–or shouldn’t be anyway. Instead it’s part of a ponzi-flavored, debt-fueled circle that could easily turn from virtuous to vicious when lending conditions tighten.
    Think about it: what happens when the generous lending terms go away? Then the whole show gets thrown in reverse. The invisible buyout premium disappears… a lot of over-leveraged players get hurt… liquidity evaporates as credit lines get recalled (multiplier effect in reverse)… stock bought on margin gets sold. The fee collectors win and the bagholders get burned–as usual.
    It’s the same old song and dance: pump and dump with a twist.

  4. I agree with Chris; institutional investors are increasing their allocations to private equity/LBO funds and reducing public equity in their portfolios. So to a large degree, the shift in ownership of companies is not changing. You could make an argument that these transactions are merely fee generators for the PE/LBO people that are unlikely to generate significant returns for the institutions; due to the big name PE people doing massive numbers of deals, it’s unlikely that they are going to get down and make meaningful change at the operational level of the companies being bought.

  5. To a rational equity investor it shouldn’t matter if the supply shrinks. There will still be equities and it they will have a value. Do you overpay for equity because the supply of it is limited? No. Do you have to buy equity or are there alternatives? The alternative is essentially bonds and foreign equities. At some point bonds and foreign equities may be more attractive than scarce US equity. I don’t care if there are only 50 stocks left to buy in USA. I will attempt to value them and if they are overpriced, I will not buy them. I will invest Elsewhere.

  6. Reading all these comments rationalizing away the importance of a shrinking equity supply makes me recall the Guido Sarducci 5 minute univeristy – everything you need to know about economics:
    (read in faux Italian accent:) “Supply and Demand”
    No matter what the rationalization is, it’s hard to ignore Guido.

  7. John … spend a few minutes actually trying to understand the concept of capital structures ala Modigliani-Miller and you’ll find out that it’s not simply a rationalization.