Flow of funds: Equities Q2 2004

Equity prices moved slightly higher during the second quarter of 2004, driven by motivated buying on the part of domestic issuers, mutual funds, and life insurance companies.

The primary sellers into this market were foreign issuers and domestic households, following a long-established pattern of behavior.

The motivation of domestic corporations to repurchase their own stock to give value to executive stock options is discussed at length on the web pages of the Center for Capital Flow Analysis.

(see: Buybacks and Options).

Significant levels of corporate buybacks have been observed since the 1980s, but the levels in the second quarter of 2004 were extremely high: 40% above the frenzied buybacks at the peak of the Great Bubble (1999-2000).

However, stock prices did not sky-rocket because foreign issuers came in with $161 billion (net) of stock issues to take advantage of high price-earnings ratios (and low capital costs), neutralizing the efforts of U.S. corporate executives to ramp up stock prices.

Mutual Funds: Motivated Buyers

The other major motivated buyers of equities were mutual funds ($94 billion, net) and life insurance companies ($54 billion, net). Mutual funds continued to attract investment, mainly in tax-deferred retirement arrangements, because of continued belief of individual investors in the Common Stock Legend.

Investment in shares by life insurance companies was driven by increases in pension reserves, but the level of stock investment was about half of that observed during the last years of the Great Bubble (1999-2000).

On balance, during the second quarter of 2004, American investors continued to invest money overseas in foreign corporations, while reducing the capital of domestic enterprises listed on the stock exchange.

This behavior was consistent with the long-term trend towards outsourcing American jobs by large corporations (both to small domestic non-listed businesses and foreign suppliers) and deindustrialization.

Demand for equities as a retirement vehicle continued strong, despite over-valuation and the short supply.

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