Stock Fire Sales of the Crisis Era Haunt Equity Bulls

With the biggest buyer all but ejected from the market, the prospect that a torrent of stock sales is about to be unleashed by cash-strapped companies is sowing anxiety for investors who remember the financial crisis.

While things have changed since those days, particularly in credit markets, secondary offerings are popping up among distressed firms, including United Airlines Holdings Inc., which raised $1 billion. Combined with a seize-up in buybacks, it adds to concern about something that many believe has been a major support for the market over the years — that it’s shrinking.

A repeat of the crisis blueprint isn’t unambiguously bad, of course. For all the dilution they create, stock sales are better than the alternative when you’re running out of money. It’s important to note that the S&P 500 surged 23% during the biggest year ever for equity sales, 2009. But the possibility that a wave of equity is coming is a consideration for bulls trying to figure out if the rebound has staying power.

“Some corporations may be motivated to cut debt by slashing capex or even by selling fresh shares into any stock-price rally,” TS Lombard’s chief economist, Charles Dumas, wrote in a note. “The latter being one reason why a stock market rebound is unlikely to gain much traction for a long while.”

Underwriters sold more than $230 billion of public equity in 2009, data compiled by Bloomberg show. This year, small issuers are already selling shares at the highest pace on record. Other deals by Carnival Corp., Performance Food Group Co. and Carvana Co. suggest larger issuers see equity financing as a viable alternative to borrowing.

A banker at a securities firm who asked not to be identified said he’s been busy sending pitches to companies in beaten-down industries like cruise lines. The stock market’s buoyancy since its March 23 low has been an advertisement for the proposals.

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What a contracting stock market means to investors and the public at large is hotly debated on Wall Street, though it’s clearly getting smaller. There are about 298 billion common shares outstanding among S&P 500 companies today, compared with a recent peak of 332 billion in 2010, data compiled by S&P show.

The repurchase of trillions of dollars in stock over the last decade is a major reason the number is falling, and to many it explains the market’s uncanny resilience during the 11-year bull market that ended in February. Because buybacks may fall by half in 2020 as companies slash spending, bulls are understandably worried that the cuts will happen at the same time a bunch of new shares is getting dumped on them.

“It’s certainly possible to think that is coming,” said Mike Stritch, chief investment officer for BMO Wealth Management. “More supply from firms in certain sectors would be a drag on performance. It would be the industries you’d most likely suspect would be subject to that, it’d just be another drag — energy, real estate, some industrials.”

One potentially mitigating difference between now and the financial crisis is interest rates. With lower borrowing costs in play, some issuers can use debt and equity-linked securities to limit the amount of dilution. Carnival, for example, slashed the size of its equity offering twice in one day before pricing the new shares alongside enlarged debt and convertible bonds deals.

“If yields stay where they are, I think debt looks much, much cheaper than equity. If you see a lot of equity issuance, you’d be looking at some of the over-levered parts of the U.S. equity market,” said Michael Shaoul, chief executive officer at Marketfield Asset Management LLC. Shaoul said that if a big slug of supply were to hit the market, it would probably come when the market was rallying and reflect companies shoring up their balance sheets and earnings power. “And then it’s kind of a happy story,” he said.

— With assistance by Vildana Hajric

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