The question is spurious, of course. Stocks are relevant. They reflect the value of thousands of public companies. They add financial leverage to an economy’s production. Thousands of people make their living because of them, and millions have their savings tied up in them. And, everyone knows they have doubled in value over the past four years.
But attitudes toward stocks have changed so greatly in the past four or five decades that sometimes it feels that individual stocks have become irrelevant. It is the fact their numbers have shrunk, the demonetization of wealth, the proliferation of investment intermediaries, and the increased costs and regulatory burdens of being public that are concerning.
Wealth was once something to which people aspired. It wasn’t something to be scorned public-ally, while being tapped privately by politicians. One of the main avenues to wealth was the purchase of individual equities and the building of portfolios over time. Working hard and thrift were considered virtues; the reward being that in time one could become, if not rich, at least comfortable. Attitudes have changed. On Friday, a couple of Bloomberg reporters disclosed that President Obama’s budget would prohibit taxpayers from accumulating more than $3 million in individual IRA accounts. He has been bashing the “rich” regularly, so putting his pen where his mouth is should be expected. Nevertheless, why should thrift, hard work and investment skills be punished? And, why an arbitrary number like $3 million?
Over the past few decades, individual stocks have been lumped, commodity-like, into index funds, ETFs and high frequency algorithmic trading programs. Despite the market making new highs, recent increases in capital gains taxes and stricter regulation have reduced incentives to invest – the life blood of economic growth. At the same time, the number of companies in which one can invest has been shrinking. Regulations like Sarbanes-Oxley, the ever-higher costs of being public, and the fact that the quarterly focus of analysts tends to distract management’s attention from longer term strategic plans have caused a shrinkage in the number of public companies. CFO Magazine, quoting Grant Thornton, recently stated that the number of publically-traded companies in the U.S. declined from 8,823 in 1997 to 5,091 in 2011.
An analyst with whom I used to work and who was consistently ranked number one in his industry, told me over the weekend that two thirds of the companies he once followed are gone. Simultaneously, according to SEC data, initial public offerings (IPOs) have declined. Between 1980 and 2000 they averaged 311 annually. From 2001 to 2011, the annual average has been 102. Birinyi Associates recently noted that announced corporate buybacks were $117.8 billion for the month of February, the highest in a year. At the same time, the population of the United States continues to grow. It has expanded by almost 50 million since 1997 and 100 million since 1980. And, the population is aging, with 10,000 people reaching retirement age every day. The need for investment vehicles has been growing, while the number of publically traded companies has shrunk. This, in part, explains the proliferation of so many derivative products based on underlying stocks.
The political demonetization of wealth and the ubiquity of rogue traders (and cronyism) are also taking their toll. The former seems odd, for even populist politicians like our President are constantly on the prowl for money. (Perhaps Leftist billionaires are not considered “rich?”) The latter (rogue traders) reflect the insatiable greed of bankers who reap rewards when they succeed, while losses become the responsibility of taxpayers. The former (the demonetization of wealth), has multiple fathers and has been a long time in the making. Elected officials in Washington and most government employees have fixed benefit retirement plans; thus are not subject to the necessity that most in the private sector have had to build wealth, either through direct savings or by way of defined contribution retirement plans, like IRAs and 401Ks. As a consequence, government employees have less sensitivity to the needs of those in the private sector that must save and invest for retirement.
Despite the need for households to increase their ownership of financial assets, the cumulative effect of these factors has been a decline in household ownership of stocks and mutual funds, and a drop-off in trading volume. A recent Gallup Poll indicated that 54% of all households own stock or mutual funds, down from 65% in 2007 and 67% in 2002. The number of households owning individual stocks is less than one in five. A New York Times article from a year ago suggested that average daily trading volume is about one half of what it was at its peak in the fall of 2008, and volume has fallen since. Financial and cultural incentives emanating from Washington have been misplaced.
They should be on wealth construction, not wealth destruction. Unfortunately, what has been happening is indicative of a government that foments dependency and renders responsibility. A Treasury Inspector General Report, issued August 9th, 2010, noted that average financial assets for those between the ages of 55 and 64 were $72,400, while the average income was $54,600. As a nation we are over leveraged. As a people, we have far too little investments.
Not unlike healthcare, one of the problem´s individual equities face is that the consumer has become increasingly distanced from the market. Thus today, very few individual investors have any idea what companies they own and even less what they do. The Peter Lynch concept of investing in what you know best seems as old fashioned as rotary telephones. Most investments that individuals do own are professionally managed, in mutual funds, ETFs, pension plans or 401Ks.
While professional managers have generally been good for investors, one cannot help thinking that the loss of a direct link between the investor and his or her investment has been unfortunate. Beneficiaries of retirement plans are only concerned with monthly checks, not whether they derive from the sale of corn flakes or Chevy trucks. At the same time, the relationship between companies and shareholders has changed. To a passive investment manager – an index fund or an ETF – the individual stock components are of little consequence, other than representing a percent of the portfolio. Thus, they have little interest in the vagaries of managements. With holding periods sometimes measured in minutes, quant-like funds have further changed that relationship as well. Companies’ managements often have no idea as to who owns their shares. Those who seem to care the most are activist investors whose interests may or may not be aligned with individual investors.
It must be remembered that every mutual fund, ETF or managed account, every index or quant-like product relies on individual companies. Without them, those funds would not exist. The degradation of financial success, in the interests of populism, does little to instill the long term confidence needed for economic success. An obsession with protecting investors can lead to public policy advocates destroying the very fabric of our capitalist system – a system necessary for our economic well-being. The decline in the number of publically traded companies should be a warning shot across the bow for policy makers. Stocks and their intermediaries not only have relevance, they are crucial to the financial well-being of the nation.
”Thought of the day” by Sydney Williams