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As I write this, the market is taking another beating. This isn’t big news anymore—its been happening for days now. At this point you have to wonder whether this is the beginning of a bear market, or just a small interruption in the bull market. There is no shortage of analysts willing to forecast the markets’ future direction. Some use technical analysis, pointing to calculations based on the ratios of stocks making new highs to new lows, the number of stocks advancing vs. the number declining, etc. Others take a fundamental approach looking at price/earnings ratios, interest rates, investor sentiment levels and the like. According to Charles Biderman none of that matters. Biderman says it’s not that complicated. The market simply follows the laws of supply and demand. The only important factors are the shares available to be bought (supply), and the amount of money out there to buy them (demand). Biderman refers to the amount of stock available for sale at any given time as the "float." The float is constantly changing. The float increases when new companies go public, existing companies issue more stock, or company insiders sell their stock. Float is reduced when companies buy back their stock, or get absorbed in cash takeovers. For example, if a company uses cash to buy another company, the acquired company’s stock is removed from the market, reducing the float. If a lot of cash buyouts occur, the total float reduction is significant. If the float is reduced, but the amount of money available to buy stocks remains constant, demand exceeds supply and prices rise. The money available to buy stock increases when investors buy mutual fund shares, or put additional cash directly into stocks. During times when the market is being flooded with new IPOs, the float increases dramatically, and the stock market falters unless enough new money comes in to absorb the additional shares. On the other hand, if lots of companies are buying other companies for cash, buying back their own stock, or company insiders are buying, the float drops and prices head up. Biderman calls the difference between float and available cash: "liquidity." According to Biderman, liquidity analysis explains the January effect. The January effect says stocks prices, especially small company stocks, tend to boom in January. Biderman says the number of new companies bringing their stock to market via Initial Public Offerings (IPOs) goes to zero in the period starting from Christmas through the first three or four weeks of January. That’s the time when investors pour new money into mutual funds. So you have a double whammy—a shortage of supply because of a lack of new stock issues—and increased demand from new money going into funds. Biderman points to the tail end of 1994 as another example demonstrating the effectiveness of liquidity analysis. The market didn’t do much in ’94, but took off like a rocket in early ’95. He says, "If you look at our liquidity numbers from where the market last bottomed, in December of ’94, you can see that from that point on … the float of shares was shrinking. In other words, starting in fall of ’94, cash takeovers of public companies and stock buybacks were greater than new offerings and insider selling. So the available float of shares kept shrinking." Meanwhile, the supply side, money flowing into equity mutual funds soared from $77 billion in ’94 to $118 billion in ’95, and then $176 billion in ’96. You often hear mutual fund inflows or outflows quoted in the media. Commentators often attach predictive significance to the fund flow data. . For instance, if investors pulled money out of funds during a particular week, they’ll interpret the data as a sign of market weakness. It’s tempting to make that simplification because stock supply or float data is difficult to obtain. But Biderman’s research shows mutual fund flows by themselves don’t mean much. For instance, the sudden drop in October 1987 spooked investors for over a year. They took $11 billion out of equity mutual funds in 1988. So the market dropped in ’88? Wrong! It went up 12 percent plus! Why? Because in 1988, over $130 billion of cash takeovers were completed—considerably reducing the stock float. Demand went down a little, but the float (supply) went down much more, forcing prices up. Biderman runs Trim Tab Financial Services, a company selling liquidity data to portfolio managers and other market professionals. Trim Tabs’ Web site (www.trimtabs.com) gives you free access to the same reports they send to paying customers, except they’re posted a couple of days later. You can download three different reports from the site: Daily Liquidity Trim Tabs, Liquidity Trim Tabs (weekly), and Mutual Fund Trim Tabs (weekly). I found the weekly Liquidity Trim Tabs report the most useful. It provides more detail than I need, but includes Biderman’s interpretation of the information. The report is posted on the Web site on Wednesdays. You need an Acrobat Reader (available free at the Web site) to download the report. Click on "An Interview With Charles Biderman" for more details on liquidity analysis. Liquidity
is a long-term indicator; it doesn’t reflect short-term
influences such as Alan Greenspan’s latest pronouncements or presidential
problems. Liquidity only works for the market as a whole—it
doesn’t tell you whether Netscape is worth more than General Motors. |
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