Supply/Demand for stocks

10:16:

The supply and demand picture is bearish fro the stock market. Supply has picked up due to the need of banks to recapitalize, while demand appears weak given light M&A activity. Money is being deployed into the stock market, as it appears investors are taking risk, but weekly mutual fund flow numbers do not appear excessive, and buy back activity light. Note the following drivers of supply:

· Equity issuance is likely to be a burden this month. Before the settlement of Simon Property (SPG), MS, and WFC, about $4.7 bln in new issue had been priced. When MS and WFC are included, the number rises about $11 bln to $15.7 bln. Assuming that BAC sells $11 bln in stock as expected, the number will reach about $27 bln. There are also a few smaller secondary deals which need to be included. DSX, LLC, and DNDN are a few names. No accounting is made for any regional bank issuance needs. It looks like secondary issue will easily exceed March’s level of $16.7 bln and be the largest since September 1997 when $32.8 bln was sold. The recent high in secondary issue occurred in October 2008 when $25 bln was brought to market. IPO sales will be small this month and only add marginally to the overall supply picture. IPO’s are not the story.

· M&A activity is running light. M&A announcements have totaled $27.6 bln month to date. This compares to a May 2008 total of $139.3 bln and an April 2009 total of $51.2 bln. Recently the takeover premium has eased. It is down to 31.63% month to date compared to a February, March, and April average of 60.7%. M&A has been weak despite improved conditions in the credit markets and signs of stronger economic growth. M&A needs to pick up to support the market and confirm stocks still have value after their spring rally.

The graphic displays the difference between M&A announcements and new issue. The data is smoothed to highlight the trend. Notice that equity prices tend to rally when M&A activity is strong relative to new issue, and the S&P 500 tends to decline when new issue is strong to M&A activity. The relationship is not perfect, but there is a growing divergence with stock prices rising and supply increasing on a relative basis. The last data point on supply assumes no change in M&A into month end and estimated supply of $27 bln in new issuance.