Fools rush in to stock market

There is an old saying, “Fools rush in where angels fear to tread.” That is particularly appropriate nowadays about the stock market.

One must begin by considering the investment sector. The main source of gross private domestic investment is the retained earnings of business. That is, the expenditure comes from depreciation accruals from profits that have been kept in the business.

However, gross investment expenditures are considerably larger than retained earnings. The difference represents funds that business obtains by direct borrowing or by sale of new issues of stock, or indirectly via insurance companies or pension funds.

That explains the basic reason for the stock market; it enables companies to issue stock for investment. That seems to be almost forgotten. Brokers act as the transmission agents between companies and the public. Thus, the main function of the stock market is that it provides an access to capital from clients.

The stock supposedly supplies the spark of innovation that makes the greatest wealth-creation machine the world has ever known. Only that is not how things unfolded. Recently major brokerage firms have set up funds through which wealthy clients could own a share of a newly listed company for a minimum of say, several million dollars. The public and regulators have objected to the fact that wealthy investors and speculators gain access to “hot” companies when the less wealthy are unable to do so.

That is the latest sign that something is wrong with the investment community, which has become disconnected from the primary function of uniting business with investors.

There are other difficulties with the stock market, too. The great bulk of trades involve no human at all, but rather sophisticated computer programs that swap stocks with lightning speed. It is no surprise then that many institutions are buying alternative assets, like toll roads or Russian timberland. The idea that the stock market was to raise capital seems to be increasingly ignored.

Furthermore, stock markets are dangerously short-sighted, According to the New York Stock Exchange in the 1960s the holding period for stocks was eight years. By 1990 it had fallen to two years and now the average stock is held for just nine months.

As investors have shortened their time horizon, companies have focused on each next quarter. One reason investor time perspectives have shrunk so much is that hedge funds have been making massive gambles using borrowed capital.

What is the solution for all that? Investors must be tempted to hold their shares longer. For instance, if a share were held for perhaps two years there would be no capital gains taxes.

Also, the government should stop debasing our currency and running huge deficits. A more normally functioning economy would attract less wild speculation.  In the meantime, the stock market will remain a dangerous place, not just for companies, but also for regular investors.


Bruce Whitestone