Facts are facts, but their interpretation is often subject to preconceived notions that can be easily misunderstood.

US households have been net sellers of stocks for some time, which is a fact. The interpretation of this fact, however, can go badly awry.

The dangerous implicit assumption is that households are selling because they want to reduce their exposure to equities. That inference is incorrect. Rather, households are selling because companies are buying back shares and reducing the supply outstanding, which effectively forces households to sell.

And if households don’t really want to reduce their equity exposure, but are merely selling to try to swap into other equities, their collective efforts will drive up stock prices to higher levels.

Households have been sizeable net sellers of stock for years. In 2016, households (including non-profit organisations) sold $195.5 billion (Dh717.4 billion) of equities, according to the Fed’s latest Flow of Funds report. They also sold $116.6 billion in mutual funds, but purchased $188.4 billion in exchange-traded funds.

So, households were net sellers of $123.7 billion in equities — and hardly for the first time.

This is thought to be worrisome in some circles because households are bailing on their stock holdings at a time when valuations are supposedly stretched. If households are beginning to flee now, it is argued this is an early sign of a large impending decline in stock prices, as households really start heading for the hills.

This makes for a good story, but it’s wrong.

New share issuance

The key to a proper understanding of what is happening is to examine the behaviour of the nonfinancial corporate sector. US companies in 2016 sold a net negative $586.1 billion, meaning that businesses bought back this amount of shares outstanding, net of new share issuance.

Plenty of companies go public via an initial public offering, or other companies issue stock in secondary offerings, and both increase the float of shares outstanding. But even more companies have been using their growing profits (or debt issuance) to finance repurchases of their own shares or to acquire other companies for cash.

This reduces the number of shares outstanding. On a net basis, companies have been major buyers of their own publicly traded stock. Implicitly, companies are suggesting they think their shares are not overvalued and they represent a good use of corporate capital.

If companies bought back $586.1 billion in shares and households sold only $123.7 billion, everyone else collectively sold the difference, $462.4 billion, a whopping amount.

These sellers include financial companies, foreign investors and central banks.

So, what are we to make from these data? The driving force in this process is unquestionably the corporate sector, since it makes the key decision whether to issue new stock or to buy back shares. Households and everyone else are mostly just trading ownership among themselves.

We are collectively buyers or sellers merely as the complement to the activity of corporations. So if the corporate sector chooses to buy back stock in significant amounts, households become net sellers unless individuals become so aggressive in their efforts to buy shares that they force the remaining players to become net sellers.

Share valuations

In fact, households don’t seem to want to reduce their stock holdings. Although households were net sellers of stock in 2016, their holdings in equities increased! The appreciating stock market caused share valuations to rise by more than households sold.

So, while households were net sellers of equities in 2016, their holdings of stocks increased and their activities reveal little about whether the stock market is overvalued or at risk of a sizeable decline.

Instead, given that households are still allowing the value of their net holdings to increase, it seems more likely that they are quite happy to add to their equity portfolios. This is very tough to accomplish when corporations are buying back stock and shrinking the floating supply of shares.

But as households add equities to their portfolios, they provide considerable support to stock prices.