Honey, We Shrunk The Stock Market
Number of stocks in the Wilshire 5000 Total Market Index – 3800
2015 Buyback Authorizations (through November) – $782 billion – up $200 billion or 34% from last year (source: Birinyi Associates)
2015 US IPO Pricings -168 – down 39% from 275 last year (source: Renaissance Capital )
2015 US Domestic Equity Mutual Funds outflows – $148 billion (source: ICI )
US-listed ETF assets – $2.1 trillion – up $215 billion or 11% from last year (source: ICI )
Number of US-listed ETF’s – 1,555 -up 11% from 1,403 last year (source: ICI )
The above numbers tell the story that the US stock market is shrinking.
1) While buybacks (fueled by cheap money courtesy of the Federal Reserve) have continued to soar, IPO’s continue to shrink. Our good friend, David Weild, has done considerable research on the shrinking IPO subject and he believes that the post-Reg NMS equity market structure is one of the primary causes for the decline. David quantified the effect that the lack of IPO’s has had on the US stock market in this interview:
“We would have over 13,000 publicly listed companies today instead of the paltry 5,000 we now have,” David Weild, chief executive of Weild & Co. and former Nasdaq vice chairman, told The Post. And that has also resulted in subdued volumes, with stock market participants sidelined by a dearth of initial public offerings, Weild said.
Because of the changes, he added, the US has averaged 160 IPOs each year the past 15 years — rather than the 950 his studies claim would otherwise materialize.
2) While the ETF market continues to attract more passive money, the active part of the fund management market continues to shrink. Another one of our good friends, Tim Quast of ModernIR, wrote a great explanation in Traders Magazine on how ETF’s differ from actual stocks:
ETFs in effect cut out the middle man, the stock market. ETFs can substitute cash or securities like options and futures for stocks, or sample the indexes they track. There are only two ETF types, physical and synthetic, with the former either owning shares or sampling them, and the latter relying on derivatives to represent the value of stocks. ETFs track indexes four ways:
1) Full replication. The ETF buys all stocks in the underlying index, matching comparative weighting. It may substitute cash for some or all of the stocks.
2) Sampling. When the tracking index is large or if the stocks aren’t available in sufficient quantity, an ETF may construct a representative sample of the index and own only those stocks.
3) Optimization. This quantitative approach uses mathematical models to construct correlation in a set of securities that trade like the index whether they reflect industry characteristics or not.
4) Swap-replication. ETFs pay counterparties for rights to the economic value of underlying indices. No assets actually trade hands.
Tim goes on to explain in the article some of the hidden dangers of ETF’s (which are really derivative products):
“The risk I propose here may never manifest. But in the May 6, 2010 Flash Crash, 70% of halted securities were ETFs. On Aug 24, 2015 when markets plunged, there were 1,000 ETF volatility halts. Too many ETFs are dependent on the same stocks. When underlying share-prices experience prolonged flattening, derivatives predicated on them may be rendered worthless.”
We all know that the equity market has changed over the past decade but the above numbers prove that point. If the market demands more passive products, then the equity market will continue to evolve. However, we think investors need to be careful for what they wish for. While they may be demanding lower fees and more ETF’s, they also need to realize that these demands will continue to hollow out the equity market. Traditional brokerage services like sell-side research and capital commitments will continue to diminish. And on the flip side, high-speed proprietary traders, who do not provide any of these traditional services, will continue to grow and dominate the equity market volume.