By MARK HULBERT
Published: February 24, 2008
FROM at least one perspective, the stock market peak of last October was not accompanied by the speculative excesses found at the height of previous bull markets. This raises hope that the market decline that began in the fall may not turn out to be severe — and that it may have already run its course.
The indicator in question focuses on corporate money-raising. Considerable research has shown that when companies turn aggressively to the equity market for their financing needs, through new issues or secondary offerings, it is a sign that the stock market is overvalued. Though there is no easy way to interpret the data, current trends in corporate finance appear no worse than neutral for the stock market’s intermediate-term prospects. And the data may actually be painting a bullish picture.
Owen A. Lamont, a former finance professor at Yale and now a fellow at its International Center for Finance, has studied shifts in companies’ use of the equity market to raise money. He has constructed a gauge, which some have called the new-list indicator, based on the percentage of all publicly traded shares that began trading in the trailing 36 months. This proportion increases as new companies go public or already-public companies issue more shares, and decreases as companies engage in stock repurchases or mergers and acquisitions.
Professor Lamont, who is also a portfolio manager at DKR Capital, a hedge fund in Stamford, Conn., has calculated the new-list percentage back to 1929. Its all-time high was nearly 15 percent, at the beginning of the Depression. Its second-highest level, almost 11 percent, was in March 2000, just before the Internet bubble burst. (He published these results in 2002 in an academic working paper.)
Where does the new-list percentage stand now? In an interview, Professor Lamont said it was at 5.1 percent, or right in line with its long-term average. When the market hit its high in October, he said, his indicator stood at just 5.6 percent. That was only marginally higher than where it finished the year, and about half its level at the market top in March 2000. By this measure of speculative activity, the current market is markedly less overheated than it was before the bursting of the Internet bubble.
A RELATED and even more encouraging indicator focuses on the relative proportion of new corporate cash that comes from equity as opposed to debt. Researchers have found that in past periods when stocks were overvalued, companies greatly preferred equity over debt. The opposite tended to be the case when stocks were undervalued.
Two researchers who have studied these patterns are Malcolm P. Baker, a finance professor at Harvard Business School, and Jeffrey Wurgler, a finance professor at New York University. For each year from 1927 through 1996, the professors calculated the share of total capital raised by publicly traded corporations that came from issuing stock — what they call the equity share.
Over the 12 months after the quartile of years with the lowest equity shares (when this proportion was no higher than 14 percent) the stock market returned an average of 14 percent, according to the professors. In contrast, the market had an average net loss of 6 percent following the quartile of years with the highest equity shares (when this proportion was no lower than 27 percent). Their results were published in the October 2000 issue of the Journal of Finance.
Where does the equity share stand now? In an e-mail message, Professor Wurgler said it was 6.1 percent for 2007 through September, the latest date for which data are available. Because this puts the current market solidly in the quartile of past years that were followed by above-average returns, he says the data are sending “a bullish stock market signal.”
In separate interviews, he and Professor Baker hastened to add that this bullish signal by no means justifies throwing caution to the wind. They pointed out that companies have had far easier access to cheap debt financing in recent years than they did in earlier decades. As a result, they argued, the current low equity share may not be strictly comparable with similarly low previous readings — and thus may not be as bullish as it otherwise would appear.
But judging from how companies have been raising new money, Professor Baker said, there was little evidence of extreme levels of speculation at the recent stock market high. At least to this extent, he said, this means that “there is less downside risk in the market today than there was in March 2000.”
Mark Hulbert is editor of The Hulbert Financial Digest, a service of MarketWatch.
Edited by milbank, 24 February 2008 - 05:22 PM.
