Too Little Confidence and Too Many Shares

Of late, there's been a lot of consternation about why the stock market isn't faring better despite reports suggesting the economy is recovering. The latest comes this morning after the release of the ISM non-manufacturing index, which rose to 60.1 in May vs. the consensus estimate of 56.0 and 55.3 in April.

Despite that report -- and comments late yesterday from Fed Chairman Alan Greenspan that were deemed positive (although that's subject to debate) -- stock proxies were struggling to make any headway at midday, although the Dow recently spurted higher.

Market players and pundits have suggested several reasons for the inability of stocks to react favorably to positive economic news, including the loss of confidence in corporate America, a lack of faith in the data themselves, and, of course, fears of terrorism and other geopolitical concerns.

The above are certainly factors in the market's malaise. But another issue to consider is the supply of stock. If there's one thing I've learned from reading Jim Cramer's missives over the years, it's that supply is the enemy of the bull, and there's been a lot of it coming of late. (Supply, that is.)

Charles Biderman, publisher of Liquidity Trim Tabs, noted today that $8 billion worth of new and secondary offerings are scheduled to price this week, citing data from Dealogic. Last night, for example, Veridian (VNX) raised $216 million in a 13.5-million-share offering at $16 each; of late, shares of the provider of information technology to the defense industry were up $2.12, or 13.2%, to $18.12.

If all the deals scheduled to price this week come to market, that will bring the year-to-date total of additional supply to $100 billion, Biderman reported. That, in turn, will mean the net change in the trading float of shares (also including insiders sales, corporate buybacks, cash-for-stock acquisitions and corporate buybacks) will approach negative $70 billion, he continued. That compares with negative $70 billion for all of 2001 and a positive $600 billion for the years 1994 to 1999.

"The net change in trading float of shares is the best leading indicator of what the market will do," Biderman said, adding that heavy selling by corporate insiders says far more about how the economy is doing than any government data (about which he was highly skeptical). In the eight weeks prior to this one, there were 4.2 insider sales for every insider purchase, The New York Times recently reported, citing data from Miller Tabak. (RealMoney.com contributor Bill Fleckenstein reported that that translated into dollar volume of $18 of insider sales for every $1 of purchases last week.)

Biderman heaped criticism on Wall Street for its constant heaping of new supply onto the market. While generating big profits for underwriters -- he estimated between $3 billion and $4 billion from the $100 billion of new supply this year, given commissions of 8% on IPOs and 2% on secondary offerings -- the constant stream of additional stock has kept constant pressure on the stock market and, therefore, investors.

The stock market is ostensibly designed to serve as a source of capital for business, but Biderman suggested its main function is really "to separate investors from their money on an ongoing basis" but do so in a way that keeps 'em coming back for more. Yes, very much like a casino -- with the brokerage firms acting as croupier.

The supply is particularly onerous because it is coming at a time of lessening inflows into small- and mid-cap value mutual funds and continued outflows from big-cap growth funds. The Investment Company Institute reported last week that year to date, all equity funds tallied net new cash inflow of $66.84 billion through April. But Biderman said there's been overall net outflow in the past couple of weeks, and he suggested the process will likely accelerate if small- and mid-cap value stocks continue to falter.

Big vs. Small

Everybody, it seems, is weighing in on this big- vs. small-cap debate, which this column has addressed frequently since late April, when Bank of America's Tom McManus suggested there was little value left in small- and mid-cap value stocks.

Last night I quoted Kevin Depew of Dorsey Wright & Associates as saying small- and mid-caps may have peaked but they retain relative strength vs. big-caps. This morning, he sent some additional info on the subject:

The relative strength chart of the S&P Mid-Cap 400 flashed a "buy" signal on Aug. 29, 2000. Since then, the Mid-Cap Index has outperformed the S&P 500 by about 27 basis points. The Mid-Cap's relative strength vs. the S&P 500 hasn't really waned since, Depew said, but it's bullish percentage chart has and is now flashing a defensive sign (on a point and figure chart). The S&P Small-Cap Index is presenting a very similar pattern of declining absolute strength but ongoing relative strength vs. big caps, he added.

In sum, Dorsey Wright & Associates expects small- and mid-caps to continue to post relative strength vs. big caps, but they are wary of all stocks right now, as reported last night.

Another view, entirely, comes from a reader (and fund manager) who suggested the real debate shouldn't be about market cap, but style, as in growth vs. value.

Judging by the Russell 2000 Value and Growth indexes, value has trumped growth in the past one-year (Value 9% vs. Growth -20%), two-year (35% vs. -39%), five-year (42% and -5%) and 10-year periods (109% vs. 23%), according to Baseline.

Going forward, however, the source forecasts that "growth investing will regress toward the mean, which implies investors using a growth style across any and all capitalization classes will do better than value investors."

In other words, the last shall be the first.

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