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For anyone who has ever sat through even the
most basic economics class, struggled through the
mid-term and final exams, and then promptly forgot all
things economic, my guess is that one undeniable
axiom remained firmly embedded: prices are
determined by supply and demand.
So why then, during times of increased market
volatility, do investors invariably put forth varied and
complex reasoning to explain what is arguably
attributable to that fundamental tenet of Econ 101?
Simply put, price volatility arises when supply and
demand are temporarily mismatched.
Though the statement appears somewhat flippant,
I assure you the underlying logic is irrefutable. Rising
equity prices suggest that demand is stronger than
supply, and falling equity prices describes the
opposite imbalance. It goes without saying that prices
can fluctuate broadly in the short-term without
establishing any identifiable trends. But in the long
term, I suggest, and the Federal Reserve’s (Fed) Flow
of Funds data supports, that (in the simplest Econ 101
terms) rising equity prices are inexorability linked with
rising demand and falling supply.1
The accompanying chart from Ned Davis
Research2 illustrates this point. The top portion shows
the quarterly values of the S&P 500® Index3 from
early 1952 to through the third quarter of 2006 and the
bottom portion reflects the quarterly rate of net
issuance of corporate equity securities over the same
period. The chart depicts that since 1984 net equity
issuance has declined steadily as equity prices have
risen.
This relationship between declining issuance and
rising prices naturally leads me to ask the question, is
correlation causation?
Putting forth the very important caveat that past
performance is no assurance of future returns, I
suggest the chart paints a compelling picture: stock
buybacks appear to be an important long-term factor
in rising equity prices.
Granted, though the data for the fourth quarter of
2006 has yet to be released, if activity in early 2007 is
any indication (the announced buyback total is
running $16 billion above the same period last year4)
the influence of supply and demand remains, I
believe, as important a market metric as any crossing
the headlines.
1 FRB: Z.1 Release--Flow of Funds Accounts of the United
States--December 7, 2006.
2 Chart S470 Ned Davis Research, Inc. ©2007
3 The Standard and Poor’s 500® Index (S&P 500) is a
broad-based index, the performance of which is based on
the performance of 500 widely-held common stocks chosen
for market size, liquidity and industry group representation.
The index does not include any expenses, fees or sales charges, which would lower performance. The index is
unmanaged and should not be considered an investment. It
is not possible to invest directly in an index.
4 “Stock Buybacks Growing by the Day,” by Joe Bel Bruno,
February 21, 2007, AP News, ©2007.
This material has been prepared using sources of information generally believed to be reliable. No representation can be made as to its
accuracy. The forecasts and opinions in this piece are not necessarily those of Van Kampen, and may not actually come to pass. Information
in this report does not pertain to any Van Kampen product and is not a solicitation for any product.
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