Monthly Brief April 2019 – Market Participation

Monthly Brief April 2019 – Market Participation

CAPITAL MARKETS

April looked to be a month of “the more things change, the more they stay the same”.  Global equity markets continued to move higher, yet without much in the way of new developments in the geopolitical realm.  Issues regarding trade, Brexit, China’s economy and politics-in-general saw little advancement and few, if any, resolutions to the outstanding issues.  

As such, investors’ focus turned towards the Q1 earnings season and the widely publicized concerns about slowing earnings growth rates.  However, to date, earnings reports have generally been better than feared, supporting equity markets with better results than the downgraded expectations.  And markets have responded by building upon this year’s gains.  

Yet several studies have suggested that the majority of equity market gains over the past year have been due to corporations buying back their own stock, rather than the impact of investor enthusiasm over fundamental opportunities.  As reported by DATATREK, companies in the S&P 500 Index spent over $800 billion on buybacks in 2018, a record amount.  Combined with dividends paid, these companies are spending 100% of operating earnings on shareholder payments. 

While this has generated a return to equity investors, it does raise questions.  If these corporate actions have indeed accounted for much of the equity market’s gains during past months, is it a sustainable catalyst?  And, if corporate leadership sees the best use of earnings to be shareholder payouts over reinvesting in the company’s growth opportunities, what does that infer about the health of the global economy?

But maybe the equity market is saying the same thing as corporate America? While the S&P 500 Index has rebounded strongly this year, the index’s annualized return rate since the previous all-time monthly high in September 2018 is running at a meager 3.9%, a rate of return much more in line with a modestly growing, yet uncertain economy. 

CHART OF INTEREST – MARKET PARTICIPATION

Following the late-2018 decline in global equity markets, the subsequent rebound has moved swiftly to recover much of the lost ground.  Certainly, seeing the S&P 500 Index set a new high is encouraging, but the sustainability of a healthy market advance generally requires broad participation by various market participants who can be defined in many ways: institutions and individuals, traders and investors, etc.  And, typically, the broader the participation, the healthier an advance is perceived to be.

Interestingly, net flows into long-term mutual funds and exchange-traded funds (ETFs), as tracked by the Investment Company Institute, suggests not all parties are at the party.  Since early 2017, these two areas of the investment universe have experienced net outflows and, as these vehicles are heavily used for investing by individuals, it suggests that their participation has been lacking.  More recently though, this trend appears to have moderated and, while not yet positive, could be a precursor to a potential shift in sentiment.

Net outflows in mutual funds and ETFs during a market advance are not unprecedented, yet it does raise questions that individuals have not been compelled to convincingly increase their equity market participation during the sharp rebound of 2019 (at least by this metric).  While it is curious that a rebound such as what we’ve seen in 2019 would not include stronger participation by individual investors, this group’s lack of participation has been widely acknowledged and discussed this year. 

Optimistically, this data suggests that individuals could serve as a potential catalyst for further gains if they start to move money back into the markets. The pessimistic side is that recent gains are more the result of trading activity (i.e. institutional market participants) than investing.

Ultimately, it is possible that the equity market can continue to move higher with participation levels as they are.  But broader participation would be welcomed and serve to better support further advances.

James Ferrin, CFA
Chief Investment Officer


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