Are Stocks a Sucker's Bet?: Opinion
With corporate profits breaking records, Wall Street anxiously anticipates the return of the individual investor to the stock market. It may be a long wait because the little guy may have concluded investing in stocks is a sucker's bet.
Investors, as opposed to traders, buy stocks in companies whose profits they expect to rise. The conventional wisdom says stock prices will follow profits higher, but over the last two business cycles that simply hasn't happened.
In February 1998, the
S&P 500
first closed above 1000. From the first quarter of 1998 to third quarter of 2010, corporate profits were up 203%, but the average daily close of the S&P 500 was up only 7% -- about half a percent a year.
Buying stocks doesn't seem to pay anymore because most of the increased value created by higher profits has been captured by hedge funds, electronic traders, private-equity funds, and aggressive M&A shops, free standing and at major investment banks, which have multiplied over the last two decades.
Their activities, essentially, fall into two categories: aggressive trading -- exploiting complex shorting opportunities, quickly detecting and exploiting movements in trading intentions of large mutual funds and other tactics often associated with exotic hedged bets and electronic trading; and direct asset purchases -- buying underperforming companies, all or in part, to force managers to pay out large sums, rearrange their companies through mergers and divestitures, or exploit unattended business opportunities incumbent managers have been lazy about pursuing.
Not all of this is negative to stock prices or unfair.
Shrewdly synthesizing public information to identify value in companies ahead of other investors is the way stars like
became legends. Stock prices rise permanently in wake of their actions, and that's good for the ordinary investor already in the stocks they pick.
Shaping up underperforming companies likely started even before the first Greek shippers bought out rivals to discharge incompetent captains and reduce seafaring risk, spread overhead and accomplish more leverage with potters, weavers, farmers and foreign merchants.
However, too much of a good thing -- electronic trading and aggressive hedging -- can be disruptive. Look at the costs imposed by the May 6 "flash crash" or defensive tactics by corporate managers besieged by unwarranted shorting. And, consider how often private equity and M&A shops acquire companies and load up them with debt, make big payouts to dealmakers, and then later disappoint investors and creditors.
Through superior information, quick execution and aggressive marketing, traders and dealmakers capture a great deal of the potential increase in value created by new and anticipated corporate profits before that value is recognized in stock prices. This results in lavish compensation for traders and dealmakers and stock prices that don't rise with profits.
Instead of ordinary folks getting a decent return in their IRAs and Keoghs, real estate prices in the Hamptons and luxury goods sales at Manhattan's finest stores soar.
Hedge funds, electronic traders, private equity and M&A shops do act on information that is obtained through careful, legitimate research but as ongoing
Securities and Exchange Commission
investigations into insider trading and published reports on electronic voyeuring indicate, critical competitive information is obtained through unethical and perhaps illegal means. Data pried from incautious corporate officials and through electronic espionage further disadvantages opportunities for gains by individual investors and conventional mutual and pension funds.
It all sounds preposterous, but consider that
JPMorgan
(JPM) - Get Report
and
Bank of America
(BAC) - Get Report
went through the entire third quarter without a negative trading day -- no losing days on proprietary trades. Unless you believe in perfection, something stinks about the information they are using.
If someone is winning all the time, then someone else is losing. That's the ordinary investor.
Stocks have become a rigged game.
Readers Also Like:
>>Weiss: U.S. Attorney Aims Low With Trading Probe
Professor Peter Morici, of the Robert H. Smith School of Business at the University of Maryland, is a recognized expert on economic policy and international economics. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission. He is the author of 18 books and monographs and has published widely in leading public policy and business journals, including the Harvard Business Review and Foreign Policy. Morici has lectured and offered executive programs at more than 100 institutions, including Columbia University, the Harvard Business School and Oxford University. His views are frequently featured on CNN, CBS, BBC, FOX, ABC, CNBC, NPR, NPB and national broadcast networks around the world.
