Equity Market - Record Increase in Supply Meets Extreme Risk Aversion
Equity prices, like the prices of everything, are determined by the interaction of supply and demand factors. The latest flow-of -funds data from the Federal Reserve have an interesting factoid on the supply-side of the equities-price equation. In the fourth quarter of last year, net issuance of domestic corporate equities totaled $986 billion at a seasonally-adjusted annual rate - a record dollar amount of issuance (see Chart 1). This also was a record issuance relative to nominal GDP - 6.9% (see Chart 2).
Chart 1
Chart 2
Who was doing all of this issuing? Chart 3 shows us that it was the financial system, desperate for new capital to replace a huge amount of old "depreciated" capital, that was doing all the issuing. At a seasonally-adjusted annual rate, financial institutions were net issuers of equity to the tune of $1.4 trillion in the last year's fourth quarter while nonfinancial corporations were net "retirers" of $450 billion of equity.
Chart 3
At the same time the financial institutions were issuing record absolute and relative amounts of new equity, I think it is safe to say that investors' demand for financial institutions' equities was somewhat inhibited. Chart 4 shows that the yield on AA-rated debt issued by financial institutions was rising sharply in both absolute terms as well as relative to AA-rated debt issued by industrial corporations. If investors were becoming much more risk averse with regard to financial institutions' investment grade debt, it stands to reason they were more risk averse with regard to financial institutions' equity capital.
Chart 4
In sum, there is no mystery as to why the broad U.S. stock indexes took a dive in the fourth quarter of last year. It simply was a matter of an increase in supply accompanied a decrease in demand.
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Author: Paul Kasriel
Paul L. Kasriel
Director of Economic Research
The Northern Trust Company
Economic Research Department
Positive Economic Commentary
"The economics of what is, rather than what you might like it to be."
50 South LaSalle Street, Chicago, Illinois 60675
Paul joined the economic research unit of The Northern Trust Company in 1986 as Vice President and Economist, being named Senior Vice President and Director of Economic Research in 2000. His economic and interest rate forecasts are used both internally and by clients. The accuracy of the Economic Research Department's forecasts has consistently been highly-ranked in the Blue Chip survey of about 50 forecasters over the years. To that point, Paul received the prestigious 2006 Lawrence R. Klein Award for having the most accurate economic forecast among the Blue Chip survey participants for the years 2002 through 2005. The accuracy of Paul's 2008 economic forecast was ranked in the top five of The Wall Street Journal survey panel of economists. In January 2009, The Wall Street Journal and Forbes cited Paul as one of the few who identified early on the formation of the housing bubble and foresaw the economic and financial market havoc that would ensue after the bubble inevitably burst. Through written commentaries containing his straightforward and often nonconsensus analysis of economic and financial market issues, Paul has developed a loyal following in the financial community. The Northern's economic website was listed as one of the top ten most interesting by The Wall Street Journal. Paul is the co-author of a book entitled Seven Indicators That Move Markets.
Paul began his career as a research economist at the Federal Reserve Bank of Chicago. He has taught courses in finance at the DePaul University Kellstadt Graduate School of Business and at the Northwestern University Kellogg Graduate School of Management. Paul serves on the Economic Advisory Committee of the American Bankers Association.
The opinions expressed herein are those of the author and do not necessarily represent the views of The Northern Trust Company. The information herein is based on sources which The Northern Trust Company believes to be reliable, but we cannot warrant its accuracy or completeness. Such information is subject to change and is not intended to influence your investment decisions.
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