US Stock Market Resilience: The Role of Supply and Demand

For investment strategists, reeling off the reasons for the U.S. stock market's steady rise after the financial crisis is second nature. As Bank of America Global Research's team points out, U.S. large-cap profit margins have steadily expanded, and earnings volatility has also decreased. In the balance sheets of S&P 500 (SPX) component companies, floating-rate debt has been almost entirely cleared. The rise of U.S. tech giants like Microsoft (MSFT) and Apple (AAPL) has not only had a transformative impact on the global economy but has also generated enormous profits.

But ultimately, the role played by supply and demand imbalances in the stock market may be more significant than many realize. At least, that's what Michael Cembalest, Chairman of Market and Investment Strategy at Morgan Stanley Investment Management, believes. In a report released earlier this week, he described this supply and demand imbalance as "one of the most overlooked factors protecting the stock market from volatility shocks."

"I am not a market technician, but I do believe that the continuous decrease in net stock supply since 2011 has helped the U.S. stock market maintain its resilience in the face of various shocks. If you agree that supply and demand conditions affect commodity prices and labor prices, then there is every reason to believe that these conditions also affect financial asset prices," Cembalest said in the report.

Global Net Stock Supply

Cembalest shows in the report's charts that the supply of U.S. stocks denominated in dollars has generally trended toward contraction since 2011. The market boom during the COVID-19 pandemic was a significant but short-lived exception – when IPO (initial public offering) activity surged.

Cembalest says that corporate buybacks of their own shares are an important factor driving this trend. At the same time, the infusion of funds into fixed-income pension plans and defined-contribution pension plans provides continuous buying for stocks. He added that although these financial injections have decreased as a percentage of the total market capitalization of the S&P 500 over the years, the annual inflow of $1.5 trillion still needs to find a place to invest.

Admittedly, investors have dealt with stock sell-offs several times since 2011. But only two have truly evolved into bear markets: one was the bear market of 2022 - which led to the S&P 500's worst annual performance since 2008; the other was the sell-off triggered by the COVID-19 pandemic in March 2020. The latter was short-lived, and by the late summer of 2020, the stock market had recovered all its losses.

On Thursday, U.S. stocks closed lower, with the S&P 500, Dow, and Nasdaq all falling. This was the first time since March that all three indexes had experienced consecutive three-day declines.

Factors influencing Supply and Demand: Besides buybacks and pension funds, interest rates and government monetary policies can also influence stock market supply and demand. Higher interest rates often make bonds more attractive, potentially reducing demand for stocks. Technological advancements in trading platforms can also affect market liquidity and volatility, influencing both supply and demand dynamics.