The Market's Supply and Demand Problem - TheStreet

At the start of the week, some of Wall Street's top market analysts said U.S. stocks were cheap and poised to rally. So much for their analysis.

The

Dow

industrials fell to a seven-month low earlier Friday while the

Nasdaq

came within 58 points of its September nadir, as investors viewed a bombing in Pakistan and a sales warning from

Sprint

(FON)

and a subscriber shortfall from

Sprint PCS

(PCS)

as yet more excuses to dump stocks.

"The bottom line is we have a crisis of confidence," said Jay Suskind, head of institutional equity trading at Ryan Beck & Co. "Any news, good, bad or indifferent is going to take the market down."

Besides the usual worries over earnings, terrorism and corporate governance, the market is also being flooded with new equity, creating too much supply as demand continues to diminish.

According to Dealogic, there was one IPO and 10 U.S. registered follow-on offerings this week, raising a total of $2 billion. In the comparable week last year, 10 follow-on offerings raised $1.7 billion while five IPOs raised proceeds of $9.7 billion.

"The trading float is growing dramatically even though new offerings and insider selling are slightly down year over year," said Charles Biderman, publisher of Trim Tabs. "What really plunged was cash takeovers and stock buybacks, so companies are very heavy net sellers not because they're selling more but because they're buying back less."

One reason that companies are buying back less stock is because some of the serial acquirers, like

Tyco

and

General Electric

, are no longer being as aggressive on that front, Biderman suggested.

The abundance of supply is being compounded by large outflows from mutual funds. Net redemptions at domestic equity funds amounted to $2.8 billion for the week ended Wednesday. In the prior week, the outflows were smaller, totaling $1.6 billion.

Equity funds experienced two consecutive weeks of outflows for the first time since Jan. 2, 2002, according to Brian Belsky, an analyst at U.S. Bancorp Piper Jaffray.

"The break in the alternating pattern seen over the previous eight weeks reinforces our belief that investors remain uneasy about the near-term prospects of equities," he said.

Despite the overall bleak picture, several analysts point to some encouraging indicators that suggest the market may be getting washed out.

The put-call ratio, one of the most consistent ways to measure market psychology, got as high as 145% Friday morning, according to Don Hays, President of Hays Advisory Group. That means many more people were buying options to sell stock than options to buy. This indication of investor trepidation is considered by many a bullish sign.

In addition, Hays said downside volume as measured by the Arms Index has reached levels that have only been seen in trough periods over the last 30 years. "This doesn't mean the market will turn up the next day but it does mean you're seeing excessive capitulation."

A decline in bond yields and increase in money supply also bodes well for stocks, he said, adding that valuations also are much more attractive now.

The 10-year Treasury note has dropped to 4.9% from 5.26% in the last three weeks, while the earnings yield on the

S&P 500

has increased. Forward earnings estimates have risen to $57 from $50 in late December as stock prices have continued to fall, he said.

Analysts also note that many stocks are doing much better than the major averages suggest. Indeed, some 70% of S&P 500 stocks are actually up 33% since Sept. 21.

"If you look at stocks such as

Fortune Brands

(FO)

,

Anheuser Busch

(BUD) - Get Report

,

Wendy's

(WEN) - Get Report

, the regional banks and defense stocks, they're doing just fine," noted Frank Gretz, a market analyst at Shields & Co. "The problem is they're not

heavily weighted in the averages."