Wednesday, December 11, 2013

Tapering & the Stock Market (excerpt)

Yesterday, the Fed released its latest Flow of Funds report updated through Q3. It’s loaded with an overwhelming amount of interesting data series about the economy's financial flows and consolidated balance sheets. We track lots of them in our US Flow of Funds chart book and related publications on our website.

For now, let’s focus on the ones in our US Flow of Funds: Equities. They mostly show that despite record cash flow and cash holdings by corporations, they have been borrowing at a record pace in the bond market. They’ve been using lots of the cash they’ve earned and borrowed to buy back their shares. Domestic individual investors and foreign investors are also buying more shares through mutual funds and ETFs. Let’s review the data:

(1) Asset values. The total market value of all equities rose to a record $31.2 trillion at the end of Q3, up $17.5 trillion or 127% from the low during Q1-2009. Over the same period, the Wilshire 5000 Index rose 180% to $19.2 trillion. The grand total exceeds the previous cyclical high during Q3-2007 by 22%.

(2) Valuation. The market value of all equities divided by nominal GDP rose to 1.14, the highest since Q4-2000, and well above the historical average of 0.68. That’s still well below the record high of 1.53 during Q1-2000.

(3) Corporate Finance. Corporate cash flow rose to a record $2.3 trillion (saar) during Q3. Liquid assets held by all nonfinancial corporations (NFCs) rose to a record $1.9 trillion at the end of Q3. Yet, the NFCs raised a record $665 billion in net new bond issues over the past four quarters. Apparently, some of those funds must have been used to buy back shares, as net equity issuance was minus $364 billion over the same period.

(4) Buyers. During Q3, equity mutual funds and ETFs purchased $411 billion (saar) in equities. Foreigners purchased $47 billion. Institutional investors had net sales of $93 billion. The household sector is a residual in the Fed’s FOF accounts, so the buy backs of shares tend to show up as selling by households, which was $400 billion during Q3.

So there you have it. The Fed’s ultra-easy monetary policy has encouraged corporations to issue bonds at record low interest rates and use some of the proceeds to buy back their shares. That’s boosted earnings per share and stock prices. Tapering isn’t likely to stop all this if bond yields remain low assuming that the Fed’s forward guidance convinces investors that the federal funds rate will remain near zero for a very long time. That policy would be even more credible if inflation remains near zero as well.

Today's Morning Briefing: Go With the Flow. (1) What’s next after tapering? (2) How about deflation? (3) Bullard wonders why inflation is so low when the Fed has been so easy. (4) Friedman’s theory isn’t passing the latest test. (5) Or is it doing so in Japan? (6) Abenomics boosting profits, but will it trickle down to workers? (7) Fed’s latest Flow of Funds report shows record net issuance of corporate bonds. (8) So easy Fed is also driving share buybacks, boosting earnings per share and stock prices. (More for subscribers.)

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