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Sunday, February 10, 2013

The stock-market

Economics textbooks tell you that the purpose of a stock market is to channel savings into productive business. But that is not now how it works. Professor John Kay, made a study of the functioning of the markets and has pointed out that there has been no net new capital raised in the stock market in the last 20 years.

There had been some new issues where the founder of a business wants to get cash out, and there had been some rights issues to provide new capital for businesses which had got into difficulties. But this and other new money was more than offset by the shrinkage elsewhere caused by companies being taken over, or going bust, or of others buying back their own shares rather than investing to grow their businesses. The National Association of Pension Funds recently provided figures to show that only 15 per cent of the new money saved by its members was being channelled into the UK equity market. The rest was going into bonds or overseas.

In theory the stock market  allows investors to become shareholders in existing businesses and share in their profits. But this does not work either, because as Professor Kay further pointed out, the vast bulk of those profits are creamed off by an army of intermediaries: fund managers, brokers, independent financial advisers, investment consultants, platform providers, custodians and a string of others. They make a comfortable living, but the investor rarely does. Private pension plan returns would be a third higher if only the fund managers charged at the same rate they do in Holland.

Also some traders, using computers to buy and sell within a millionth of a second so they can exploit the most minor and shortlived movements in prices. Again, they make a comfortable living. Again, it is hard to see what value they add, or how they further the primary purpose of the market. Arguably they work against it by adding to the volatility which scares off ordinary people.

Market professionals have different priorities from ordinary investors, which is why the pressure on companies is for short-term results. This means executives will cut back on research and development, think twice about making big investments which won't deliver an immediate pay-off, and will sell or close down underperforming businesses rather than spend time trying to turn them round. The financial tail wags the dog.

Great on diagnosis, Professor Kay can't think of any short-term fix. The only real hope, he says, is for investors and pension fund trustees to wise up to what is happening, understand how it is not in their interests and demand a change in City behaviour. SOYMB has a suggestion. Dump the parasitical system called capitalism.

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