We noted this morning that despite all the crises (most of which actually seem to be worsening), markets continue to improve.
Bears who finally thought they had their moment — with the perfect storm of Japan, MENA and the like — are once again shocked at the resilience of this market.
This is the topic of the latest note from Citi’s Tobias Levkovich, who looks at what he calls The Backstop Buyers keeping a firm bid underneath equities.
Who are the backstop buyers? Here are a couple of candidates
Pension funds’ likely asset allocation shifts from bonds to stocks provide substantive support. With requirements to generate 7%-8% returns to meet growing liabilities, private pension funds (particularly defined benefit programs) appear to have little option than adding to their equity portfolios, especially given low allocation to equities relative to history. In many respects, buying government and high-grade corporate bonds yielding only half the needed income increases the plausibility that some reversal of bonds flows should occur over the next year or two.
International investors continue to buy US equities. Foreign buyers have been consistent purchasers of US equities just as many US investors have shifted their attention to international opportunities. While non-US buyers have been aggressively taking on US Treasury bonds (now owning almost half of all US Treasury securities), they have been in the market for stock, too, accounting for more than 13% of US equity holdings, nearly twice the level held a decade ago. In addition, there seems to be little evidence of any change in attitude.
Another possible factor at play is the shortage of equity:
Several years ago, Citi’s global equity strategist, Robert Buckland, coined the term “de-equitization” implying that the amount of available equities for shareholders was shrinking due in part to corporate takeovers, buyback activity and private equity industry participants. With financing costs so low and the ability to raise record levels of high yield debt last year (see Figure 17), the shrinking of the equity capital base (see Figure 18) also can create a kind of “scarcity” value benefit which keeps shares from falling sharply, barring a new recession or exogenous shocks. Note that the heavy equity issuance in 2009 was due to the banking industry’s need to raise new capital after huge write-offs.
In light of all this, it’s not hard to understand why the end of QE2 has become such an object of fascination. What happens to yields, and what kind of alternatives are presented to both pension funds (i.e. investment alternatives) and companies (money-raising alternatives) will likely have a big impact on the market’s ability to keep on rallying.