Rising share issuances shrink US equity market expectations

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SIMON BROWN: I’m talking with Sahil Mahtani. He is director at Ninety One Investment Institute. Sahil, appreciate the time again today.

A fascinating research report is out from you and your colleagues. Over the last two decades US companies have been buying back more stock than they’ve been issuing. In other words, the pool of shares has literally been shrinking what’s been available to investors. These are astounding numbers.

I’d never thought of it. Intuitively, when you say it, it makes some sense. But this must also have an impact on investable returns – a shrinking pool, more money chasing fewer shares, supply and demand.

SAHIL MAHTINI: Yes. Thanks, Simon. Really good to be speaking with you. Yes, when people talk about the impact of AI on the equity market, they frequently go into the technology – what the end state return on invested capital is, and so on.

We have tackled it from a slightly different perspective, which is what the impact is of all the share issuance that’s coming onto the market.

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We all know that in the past 10 years, 15 years – really since the GFC [global financial crisis] – we have had very strong net buybacks and the buybacks have contributed to returns in the equity market. That’s why the equity market returns have been so consistent. Now that process is reversing. So that’s quite significant.

SIMON BROWN: There are a couple of points. With the capex spend we’ve seen some of the buybacks disappear. We’ve also seen these mega IPOs – SpaceX already out there, Anthropic and OpenAI potentially both coming, potentially about $1 billion.

Be a good Alphabet to actually issue script as well. We’re suddenly seeing not an avalanche, but a lot more stock coming to market – in other words, increasing the amount that’s available.

SAHIL MAHTINI: Yes, that’s right. It’s a massive amount. Figures that we have at the moment are about $4 trillion within the next three years. And keep in mind that the IPOs, when they initially happen, are usually on lowish floats. And then what happens is that over a period of one to two years you get exits from the insiders.

That’s why you see a process where the amount of float goes up by five or six times within that span of time.

So what is starting today is actually going to continue, drip, drip, drip, to at least 2028. And that should have an impact on the returns.

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SIMON BROWN: Were you able to quantify sort of what level of return the market got from the shrinking pool of issuances?

SAHIL MAHTINI: Yes, that’s right. In the last decade, if you take in repurchases issuance, and you take a net figure, you get a 0.7% improvement to returns from de-equitisation.

We think that with the IPOs that are coming out, you’re going to get a negative 4% impact over a period of time, and that is as significant as the numbers you saw in the late ’90s.

So a lot of institutional asset managers will start from future returns, and the future returns for the US equity market were already relatively low because of the high starting valuations. Our numbers are around 3%.

So suddenly you get a negative impact of 4% because you’re expecting what happened in the ’90s; that wipes out all your expected return. It’s not a certainty. These companies could do very, very well.

But what I’m saying is that the last time we have seen this level of issuance you got a pretty bad outcome. So convince me, please, this time is different.

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SIMON BROWN: [Chuckles] I like that. To be clear, we’re not calling a market top by any stretch. In a sense you’re kind of asking the question – and it’s what you said in that last conclusion there, which is: Where do the returns come for the next decade in US equities? It’s becoming a harder question to answer.

To your point. We’re at extremely elevated levels, which usually tell us the next decade is not great. You bring this into the equation, and it starts to bring some really hard questions into where those returns are.

SAHIL MAHTINI: Yes, exactly. One reason you don’t want to be calling the top is because you could be a ’97 instead of 2000, but you’ve still got three more years to go.

Another reason is you’ve still got a huge amount of issuance that’s coming through. I think the SpaceX issuance was less than 10% of the float. That should go up massively over time.

And the third reason is maybe this time is different, and maybe these companies are just incredibly super profitable, and all the capital that’s being deployed is going to earn these kinds of excess returns.

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However, what you can definitely know at this point is that the operational earnings better deliver, because you’ve suddenly got a massively increased capital base which is expecting a return on that equity. So the hurdle has been raised.

In the same way, if a company issued shares you would make sure it was getting some kind of return for that share issuance. It’s exactly the same thing at the index level.

SIMON BROWN: Yes, 100%.

So then a last question. A conversation I’ve had with you, your colleagues and other guests on this show, is the emerging market versus developed market debate.

The tilt has been shifting towards emerging markets, although it’s been a wild year. South Korea, SK Hynix – I didn’t see that coming in the EM [emerging market] space. But this kind of plays into that EM [being] preferred over the DM [developed market] debate.

SAHIL MAHTINI: Yes. EM is incredibly resilient. You’ve seen yields go up in the US. Actually EM yields have been pretty steady, so I think the story in EM is real resilience.

What is potentially happening now is the performance of non-US over US. That includes EM, but it includes other countries as well. You saw that happen last year, where the US equity market, despite doing really well, underperformed Europe, underperformed East Asia.

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So I think that could very well continue, just given the starting points and given the fact that a lot of the AI supply chain is in Asia, in EM, and given the fact that if this technology is as revolutionary as it looks, it will start to impact a lot of companies that don’t seem like tech companies in the first place. It should transform the small-, medium-sized ‘restaurant booking’ system.

It should transform a variety of other industries that are in the market. That will have an impact on Europe, it will have an impact on EM, it will have an impact on Asia.

SIMON BROWN: We’ll leave it there. Sahil Mahtini, director at the Ninety One Investment Institute, appreciate the time.

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