Equity demand from exchange-traded funds has soared so far this year as investors increasingly favor passive investing over active. Another key source of equity demand earlier this year has been share repurchases, according to Goldman Sachs, although other firms have found a more recent decline in share buybacks.
Equity demand for ETFs skyrockets
In their June 23 “US Weekly Kickstart” report, Goldman Sachs analyst David Kostin and team offered analysis of the main sources of equity demand this year. They reported that equity demand for ETFs has surged this year, reaching $98 billion just in the first quarter alone. They added that it’s on pace to surpass the total demand recorded in both 2015 and 2016 combined.
As a result of this extremely high demand for ETF equities, they boosted their full-year estimate for ETF purchases to $300 billion, which would be a record high if it reaches that level this year. They add that ETFs hold nearly 6% of the equity market, marking ETFs' highest share of the market ever. Meanwhile, ownership of mutual funds has dropped to 24%, the lowest level in more than 12 years.
ETFs face off with mutual funds
ETFs bought $98 billion worth of equities during the first quarter of this year. Equity demand from ETFs amounted to $174 billion in all of 2015 and $188 billion in all of 2016. As ETFs purchase equities, mutual funds have been unloading them, according to the Goldman team. They report that mutual funds sold $31 billion worth of equities during the first quarter, which was the sixth quarter in a row that they have been net sellers of mutual funds. They expect mutual funds to remain net sellers in all of 2017.
They add that even though mutual funds sold $31 billion worth of equities during the first quarter, net equity demand was still about $15 billion higher than it was in the third and fourth quarters of 2016. In the third quarter, net demand stood at $49 billion, while in the fourth quarter, it was at $46 billion.
Kostin and team forecast a "modest" deceleration in ETF purchases during the second half of this year versus the first quarter because they see a lower "potential for significant equity upside" through the end of the year. They also expect mutual fund demand and inflows will continue to weaken as investors continue to shift from active management to passive funds.
Equity demand among foreign investors to drop
The Goldman team notes that while U.S. stocks rose 6% during the first quarter, foreign investors boosted their share of total corporate equity ownership. They added that foreign purchases of U.S. stocks amounted to $55 billion during the first quarter. It was only the second quarter foreign investors have bought U.S. stocks out of the last eight quarters.
They expect foreign investors to go back to being net sellers of U.S. equities in the second half of the year. They're forecasting total equity demand from foreign investors to be $25 billion for all of this year, which points to net sales of $30 billion in the second half of this year.
Share repurchases were the biggest equity demand source
Kostin and team also reported that U.S. corporate equity demand, which they define as "buybacks minus issuance," amounted to $136 billion during the first quarter. It was a lower level than the six quarters immediately before it and a 10% decline from the fourth quarter. But despite that, share buybacks remained the greatest source of U.S. equity demand. They found that 22% of the buybacks among S&P 500 companies were by firms in the Financials sector, compared to the sector's five-year average contribution is 15%.
The Goldman team expects U.S. equity demand among corporates to grow 2% to reach $640 billion in all of 2017. They explain that the projected 3% increase in adjusted earnings per share this year, combined with near-record cash-to-assets levels and capacity utilization that remains below average, should drive growth in share buybacks for 2017.
No slam dunk for tax reform yet
They had previously been estimating an 11% increase in buybacks for this year, which would bring the total to $700 billion. However, they revised that estimate to reflect the delay their firm's economists are forecasting for Trump's tax reform, which will enable companies to repatriate cash at a lower tax rate. Tax reform and tax repatriation have been widely considered to be a slam dunk this year, and Barclays was buying value stocks in anticipation of the tax cuts that are expected to be part of the reform. So far, the Trump administration has failed to get anything done on this, however.
The Goldman team had been projecting between $60 billion and $70 billion in cash to be repatriated during the fourth quarter of this year, paired with $50 billion in spending on share repurchases. However, their new forecast eliminates the boost from tax reform for this year and also takes into account the first quarter's weaker-than-expected activity.