In the late 1990s, Citigroup launched a hiring wave with the goal of dominating the European stock market. This move came as investors flocked to mutual funds and publicly traded companies and there was a boom in tech stocks. However, the brutal bear market that followed put an end to these earnings opportunities for investment banks.
By 2003, the global stock market had stabilized and there were hopes of a “major rotation” from bonds back to equities. However, new accounting rules for pension funds and regulatory changes for insurance companies made it difficult for investors to own stocks. Retail investors, still cautious after the bubble burst in the late 1990s, were also reluctant to return to the stock market.
As conventional investors struggled to capture the valuation opportunities between bonds and stocks, other arbitrageurs emerged. Companies looked to the bond market for cheap capital in order to buy shares in the stock market through buybacks or takeovers. This strategy has also been fueled by the rise of private equity. The retirement of old shares through de-equilibration exceeded the issuance of new shares, resulting in declining stock markets.
The de-equitization trends were not only limited to financial transactions, but also influenced governance. Activist investors pressured underperforming companies to spin off assets and conduct share buybacks. However, this trend has met resistance in Japan, where companies have been reluctant to realize shareholder value.
Central banks believed that interest rate cuts and bond purchases would stimulate capital spending, but this largely resulted in financial manipulation rather than genuine investment. As a result, there was a political backlash, leading some countries to introduce taxes on share buybacks.
In the UK, falling equity markets have been attributed to institutional investors switching from equities to bonds on the back of commitment-oriented investment strategies. This has widened the valuation gap between the two asset classes and made de-equitation inevitable. Despite recent rate hikes, UK companies can still borrow at lower interest rates to buy assets on the stock exchange and thus generate higher earnings yields. Consequently, it makes little sense for listed companies to issue more equity or for unlisted companies to go public.
The de-equitization trend has also impacted the US market, where available stocks in the public market have been shrinking since 2000. Even the technology sector has seen a decline offset by significant buybacks. This is in contrast to the bull market of the late 1990s, when the technology sector saw a significant surge in stock issuance.
While de-equitization trading may seem less attractive now that the US stock market is trading at a yield similar to that of the corporate bond market, it is unlikely to disappear entirely. The author concludes that while they missed the opportunity to switch to private equity, de-equitization trading remains relevant, especially in Europe.
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