Supply and demand fundamentals shape pricing for all goods and services, including equities. Equity demand changes based on investor sentiment—the eagerness to own equities. It’s driven by our collective feelings, fears and hopes. Supply, on the other hand, is more mechanical and strategic, tied to corporate actions and regulatory processes. In this article we’ll discuss factors that contribute to equity supply and demand, as well as how Fisher Investments UK measures them.
Investor Sentiment Shapes Equity Demand
Investor sentiment is the primary driver of short-term equity demand, and it’s remarkably volatile. People swing from optimism to pessimism rapidly, influenced by news, economic data, politics and other events. For example, when equities perform well, more investors may want to participate in the rally. In the latter stages of a bull market, sentiment can reach euphoric levels, creating even more intense demand for stocks.
Euphoria was a key part of the 90’s bull market as investors pooled into internet-related Tech companies with unsupported fundamental drivers, ultimately leading to the dot-com crash. When investors become too excited or too fearful, it can have dramatic impacts on demand for equities. Here are some key contributors to investor sentiment that impact equity demand:
Economic Data
Although economic data like GDP, unemployment and inflation readings are backward-looking, in Fisher Investments UK’s view, they often play a role in shaping how investors feel about owning equities. Combined or singularly, they can drive short-term fluctuations in demand for equities.
Politics
Elections and other political events also impact investor sentiment. Depending on how these events develop, investors may perceive the results as better or worse for businesses in one region or sector. Whether these feelings are justified or not largely depends on the specific policies impacting those businesses and whether or not parties in power have enough control to enact their desired agenda.
Media Coverage
Fisher Investments UK knows that news and media coverage can quickly and dramatically shift sentiment. A positive earnings surprise, breakthrough in medical research or favourable trade agreement can spark buying enthusiasm. Conversely, geopolitical tensions, natural disasters or corporate scandals can quickly dampen investor appetite.
Measuring Investor Sentiment
Measuring investor sentiment is more of an art than a science. There are data that offer insight into how investors are feeling about markets, but as we’ve discussed, demand hinges on human emotion, and forecasting human emotion is tricky. Here are a few of the ways Fisher Investments UK tracks investor sentiment:
Fund Flows
Fund flows show the amount of global investors’ money flowing in and out of products like mutual funds and exchange trades funds (ETFs). Depending on which types of equities investor funds flow into, it can be indictive of either bullish or bearish investor sentiment. For example, if more money flows out of equity funds into bond funds, it could suggest investors are fearful of owning equities in the short-term.
Portfolio Positioning
Portfolio positioning refers to the decisions investors make as to the types of asset classes and sectors they emphasize or deemphasize in their portfolio. For example, if investors own more Tech stocks, their portfolios may be positioned in offensive stocks with high growth expectations. Conversely, allocating a higher percentage of a portfolio to a defensive sector like Utilities, which tends to perform better relative to other sectors during market declines, might indicate investors are worried about where the market is headed.
Surveys and Forecasts
Surveys and forecasts are one of the most common ways to measure investor sentiment. Various private and government institutions send surveys to investors, analysts and companies asking them questions about their respective industries. Forecasts can be tied to a specific industry or the market itself.
One of the most common surveys Fisher Investments UK uses to gauge sentiment are Purchasing Manager Index (PMI) surveys. These are monthly surveys sent to purchasing managers in various sectors, asking them to report on key business data like new orders, production and inventories. Answers are then aggregated to give a broader picture of how that area of the economy is doing. Readings above 50 indicate economic expansion, while readings below 50 indicate contraction.
Factors Contributing to Equity Supply
Corporate actions and market mechanisms determine equity supply. Supply operates on a longer timeframe than sentiment-driven demand. Understanding these supply factors helps explain longer-term price trends. Companies don’t create or destroy shares on a whim. There are regulatory and marketing processes, and other strategic considerations.
The run up to the dot com bubble is a classic example of investor euphoria causing demand to outpace the supply of Tech equities. This in turn led to increased IPO activity as some companies looked to capitalize on surging equity prices. This is a prime example of supply rising in response to increased demand.
Supply revolves around strategic decisions made by companies, like those during the dot com bubble. If they see a sustained demand increase, they may look to issue new shares to capitalize on the demand. Fisher Investments UK takes a closer look at some of the corporate actions and market mechanisms that increase or reduce equity supply:
Initial Public Offerings (IPOs): Increases Supply
When companies go public, they increase equity supply by selling shares of a new company to investors for the first time. The IPO process typically takes 12-18 months, involving extensive regulatory filings and marketing efforts.[i] This lengthy timeline means IPO activity can take time to ramp up once demand starts to heat up.
The volume of IPOs at any given time tends to reflect broader market conditions and corporate confidence. During bull markets, more companies go public to take advantage of higher valuations. In bear markets, IPO activity tends to slow considerably as companies wait for better conditions, according to Fisher Investments UK.
Additionally, a friendly regulatory environment can be conducive to increased IPO activity, while a more bureaucratic regulatory process may suppress companies from going public.
Secondary Offerings: Increases Supply
Companies can also increase supply through secondary offerings, issuing additional shares after their initial public offering. These offerings typically occur when companies need to raise capital for expansion, debt reduction or other cashflow needs.
Secondary offerings may pressure a companies’ stock prices in the short term because they increase the supply of shares available for trading. However, if the capital raised is deployed productively, the long-term price impact can be positive.
Special Purpose Acquisition Companies (SPACs): Increases Supply
SPACs represent a newer supply mechanism that has gained significant attention in recent years. SPACs are essentially a vehicle for taking private companies public faster through a merger. The SPAC, a publicly traded entity, is created by a group of investors, then merges with the private company on negotiated terms.
Fisher Investments UK recognizes that the process of taking a private company public is generally faster using a SPAC because the private company can take advantage of the pre-existing corporate structure of the SPAC. There is also a streamlined regulatory process for SPACs when compared to a traditional IPO.[ii]
Share Buybacks: Reduces Supply
Share buybacks represent one of the most direct ways companies can use to reduce equity supply. When a company buys back its own shares, those shares are typically retired, reducing the number of shares outstanding. All else equal, this mathematical reduction increases a companies’ earnings per share. Companies tend to buy back shares when they believe their stock is undervalued or as a way to reward shareholders.
Fisher Investments UK’s Perspective on Equity Supply and Demand
While demand fluctuates with human emotion and sentiment, creating short-term volatility, supply moves through deliberate corporate decisions and regulatory frameworks, exerting slower but more profound long-term influence. This principle aligns with Warren Buffett’s enduring wisdom: markets vote on sentiment in the short term but weigh fundamentals over longer horizons. By recognizing how supply and demand forces operate across these different timeframes, we hope investors are better equipped to make more informed investment decisions.
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This document constitutes the general views of Fisher Investments UK and should not be regarded as personalised investment or tax advice or a reflection of client performance. No assurances are made that Fisher Investments UK will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. Nothing herein is intended to be a recommendation or forecast of market conditions. Rather, it is intended to illustrate a point. Current and future markets may differ significantly from those illustrated here. In addition, no assurances are made regarding the accuracy of any assumptions made in any illustrations herein. Fisher Investments Europe Limited, trading as Fisher Investments UK, is authorised and regulated by the UK Financial Conduct Authority (FCA Number 191609) and is registered in England (Company Number 3850593). Fisher Investments Europe Limited has its registered office at: Level 18, One Canada Square, Canary Wharf, London, E14 5AX, United Kingdom. Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission.
Investment management services are provided by Fisher Investments UK’s parent company, Fisher Asset Management, LLC, trading as Fisher Investments, which is established in the US and regulated by the US Securities and Exchange Commission. Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.
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[i]Source: https://kpmg.com/kpmg-us/content/dam/kpmg/pdf/2022/why-choosing-spac-over-ipo.pdf
[ii]Source: https://kpmg.com/kpmg-us/content/dam/kpmg/pdf/2022/why-choosing-spac-over-ipo.pdf