Supply and Demand

Commentary: The supply of stock is mushrooming -- a bearish sign

What bear market?

Notwithstanding the carnage the stock market suffered between October 2007 and March of this year -- the worst since the Great Depression -- corporations' share issuance departments are partying like it's 1999.

In fact, firms have recently issued far more shares of their stock (either through initial public offerings or secondary offerings) than they did even in the go-go years of the late 1990s and at the top of the Internet bubble in early 2000.

That's not good news, from a contrarian point of view: The stock market historically has tended to perform poorly following periods in which firms have flooded the market with more shares.

Prior to May, according to TrimTabs Investment Research, the highest level of share issuance in a given month was $38 billion. May blew that record out of the water, with a monthly total of $64 billion.

Furthermore, that blistering pace has continued during the first two weeks of June, according to TrimTabs.

How bad an omen is this corporate eagerness to offer its shares to the investing public? Looking back through recent history, TrimTabs found that there have been just 12 months since 1998 in which total new corporate offerings totaled at least $30 billion. The average return for the S&P 500 index (SPX) over the 90 days following those months was a loss of 4%.

Dissecting the data further, TrimTabs next focused on those months in which not only did total corporate issuance exceed $30 billion, but also those in which total corporate share purchases were less. The S&P 500's average 90-day return following those months was a loss of 7%.

This more-narrowly-defined subset applies to today, unfortunately. According to TrimTabs, corporate new offerings since the beginning of May have been nearly five times greater than corporate purchases.

The recent surge in the supply of shares has also caught the attention of Ned Davis, the eponymous head of Ned Davis Research. He has found through his research that it is optimal not to focus on monthly totals but instead on a rolling 13-week window. On this basis, according to Davis, recent corporate issuance has been exceeded historically only by two other occasions -- early 2000 and early 2008.

Those were "not great times to buy stocks," Davis notes dryly.

Davis also draws an even more ominous parallel to the recent corporate rush to sell stock: "This high level of [recent] supply is one of the key characteristics of the monster rally in November 1929 - April 1930."

From April 1930 through the low in July 1932, of course, the Dow Jones Industrial Average (INDU) fell by 86%.

For the record, I should point out that Davis, despite these ominous portents, remains cautiously bullish for the short-term, since many of his other indicators suggest that this rally has further to run.

But TrimTabs is quite bearish, recommending that clients be 50% short U.S. equities. "Stock prices are going to fall hard," they predict.

Mark Hulbert is the founder of Hulbert Financial Digest in Annandale, Va. He has been tracking the advice of more than 160 financial newsletters since 1980.
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