Households won’t trip up the bull market

Facts are facts, but their interpretation is often subject to preconceived notions that can be easily misunderstood. Households have been net sellers of stocks for some time, which is a fact. The interpretation of this fact, however, can go badly awry. The dangerous implicit assumption is that households are selling because they want to reduce their exposure to equities. That inference is incorrect. Rather, households are selling because companies are buying back shares and reducing the supply outstanding, which effectively forces households to sell. And if households don’t really want to reduce their equity exposure, but are merely selling to try to swap into other equities, their collective efforts will drive up stock prices to higher levels.
Households have been sizable net sellers of stock for years. In 2016, households (including nonprofit organizations) sold $195.5 billion of equities, according to the Fed’s latest Flow of Funds report. They also sold $116.6 billion in mutual funds, but purchased $188.4 billion in exchange-traded funds. So, households were net sellers of $123.7 billion in equities—and hardly for the first time.
This is thought to be worrisome in some circles because households are bailing on their stock holdings at a time when valuations are supposedly stretched. If households are beginning to flee now, it is argued this is an early sign of a large impending decline in stock prices, as households really start heading for the hills. This makes for a good story, but it’s wrong.
The key to a proper understanding of what is happening is to examine the behavior of the nonfinancial corporate sector. US companies in 2016 sold a net negative $586.1 billion, meaning that businesses bought back this amount of shares outstanding, net of new share issuance. Plenty of companies go public via an initial public offering, or other companies issue stock in secondary offerings, and both increase the float of shares outstanding. But even more companies have been using their growing profits (or debt issuance) to finance repurchases of their own shares or to acquire other companies for cash. This reduces the number of shares outstanding. On a net basis, companies have been major buyers of their own publicly traded stock. Implicitly, companies are suggesting they think their shares are not overvalued and they represent a good use of corporate capital.
If companies bought back $586.1 billion in shares and households sold only $123.7 billion, everyone else collectively sold the difference, $462.4 billion, a whopping amount.
—Bloomberg