As many readers will know, I am not the greatest fan of stock markets. I consider most activity on such markets to be exploitative because of the asymmetry of the information available to investors. Much of it, from the pay directors take to the actions of most market managers, I consider to be rent seeking. The idea that equities provide strong returns is pretty much an urban myth, in my opinion, based on selective reading of data in those periods between market crashes.
There is quite a lot of evidence to support my view in an article by long-term and highly opinionated equity investor Terry Smith in the FT this morning. As he notes he did this based on 'a research paper by Hendrik Bessembinder published in the September edition of the Journal of Financial Economics posed the question “Do Stocks Outperform Treasury Bills?” with some rather worrying conclusions for most equity investors.' I should make clear that the research is US based. I have no reason to think that performance in the UK is any different.
The main conclusions is that the majority of shares do not perform nearly as well as government bonds. It is an exceptional few that make it look as though shares outperform gilts.
Since 1977 the median new shares issued on the stock exchange has delivered a negative rate of return, even with dividends reinvested.
On average, a quoted security has a life expectancy of just 7.5 years over the 90 year period studied. No wonder short-termism is rife.
And as he notes:
Just five companies out of the universe of 25,967 in the study account for 10 per cent of the total wealth creation over the 90 years, and just over 4 per cent of the companies account for all of the wealth created.
So, what is to be learned?
First, the stock exchange is not a business funding mechanism: it is a business exit strategy for most companies.
Second, most people are fools to take part in this game.
Third, if you insist on taking part only invest in the best stocks.
Fourth, since you have no way of knowing which ones they are, invest in a market tracker.
Or fifth, buy gilts.
But whatever you don't believe the story that the market deliver higher rates of return than government bonds: 96% of it does not.
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MMT identifies that Government bonds are an even less fair mechanism, and are essentially ‘welfare for the wealthy’.
Firstly, if you save sterling bonds you are already not buying output and so are stalling the economy. Why should you be rewarded for that?
Secondly, if you have £1,000 in bonds and earn £50 interest and buy food with it then in real terms that causes the farmer to feed you with his food. The bond interest causes redistribution of real goods & services and the farmer and everyone else with less money to start with loses more.
Even Warren Mosler, who made his money largely through bonds, says that the interest rate on bonds should be ZERO for these reasons.
MMT does not say that
It is not true
Some who use MMT say that
This is not the same thing
A government has a duty to be a borrower of last resort
Oh, and the real interest rate has been zero for ages, just in case you did not notcie
Not that I have a red cent to invest in anything, but there is strong evidence that you shouldn’t buy the stocks of companies busy cannibalizing themselves in the name of short term gains; aka the ones buying back all their stock to satiate their shareholders rather than reinvesting in the business.
https://www.nakedcapitalism.com/2018/07/michael-olenick-update-confirms-that-share-buybacks-are-still-corporate-suicide.html
Of courses Kalecki could have told anyone almost a century ago ‘workers spend what they get, the capitalists get what they spend.’
I once heard that all the financial sector does is move money around. It does not make any ‘new money’ as such.
Given what we know about how rental income is generated (from lower wages via wage arbitrage, asset stripping and price gouging) I’ve always seen investment as a unethical activity – the only exception for me is investment in green technologies.
Having said that, I agree with Will Hutton and Steve Keen in than the problem is also about investors wanting quicker returns and higher growth (short termism – I mean look at the phenomenon that is ‘day trading’). Keen recommends a lock in of at least 5 years and I agree.
Investing might be more tolerable if it was seen as a longer term commitment and not a get rich quick scheme.
Keynes thought trading should only be allowed for two ten minute periods a day
But now we have grey markets
That would be a paraphrase of Minsky’s “Money Manager Capitalism,” the wondrous era that Thatcher and Reagan ushered us into.
http://www.levyinstitute.org/pubs/conf_june10/Whalen.pdf
I continue to believe that markets can create value. They can (and should) be a mechanism through which resources are allocated in the way they can be most efficiently, effectively or desirably applied. I do not dispute that the stock market (like most other markets in today’s world) does not create value but that is not because it can’t. It’s because those who regulate it have chosen to do so for the benefit of its players rather than to fulfil its purpose.
If markets did allocate capital this might be true
But the reality is that they have not done that for a long time
I could not disagree more Lewis – sorry.
All I have seen in the so-called markets is the mis-allocation of money in the economic system – mostly into speculative bubbles. And yes – a minority manages to clean up and win big. But what are the majority of normal people left holding afterwards?
Answer? Sod all.
The efficient markets hypothesis is baloney. Watch the documentary The Flaw and hear Robert Shiller call it out. Have you never heard of herd behaviour? Or the hot hand fallacy?
No? Poor you.
Richard,
Before writing articles such as this one it might be worth reading the paper you are referring to first. It’s available here:
https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2900447
It’s worth noting exactly what the author says:
“The question posed in the title of this paper may seem nonsensical. The fact that stock
markets provide long-term returns that exceed the returns to low risk investments, such as
government obligations, has been extensively documented, for the US stock market as well as for many other countries. In fact, the degree to which stock markets outperform is so large that there is wide spread reference to the “equity premium puzzle.”
“The evidence that stock market returns exceed returns to government obligations in the
long run is based on broadly diversified stock market portfolios. In this paper, I instead focus attention on returns to individual common stocks.”
So as we all know, the stock market as a whole massively outperforms government bonds, and has done for a very long time and on a long term basis. What this report is saying is that bonds can outperform individual stocks on that long term basis. Which is hardly surprising as if you look at companies on a long term basis (since 1926 in this case) many of them go bust, where countries tend not to as much.
It’s hardly rocket science, but it isn’t a good argument for saying you should invest all your money in government bonds, which if you are looking for a real return are on the whole a terrible investment.
So as for your five points:
1. No. Equity capital markets are a direct funding mechanism for businesses, and the secondary market enables the primary to function properly.
2. That is just rhetoric, but historically if you buy equities over the medium to long term you will have done well – as the data shows much better than buying bonds.
3. What are the best stocks exactly?
4. Yes, invest in broad based index trackers. Have a portfolio of various stocks. Exactly what the paper you mention says you should do, and the only thing you say I actually agree with and isn’t totally wrong.
5. Buy gilts if you are worried purely about risk of capital loss, but when doing so when you buy them you will still be exposed to massive interest rate risk and will normally be losing money in real terms when holding them even without an interest rate shock.
Bear in mind that for a 10 year government bond a 1% move higher in interest rates will lead to a roughly 10% capital loss. So bonds are hardly risk free, especially at these low levels of yields.
Your conckysion is wrong
The paper does not say what you say it does
It says some equities massively outperform gilts
That is not the same thing
You can argue an index tracker gives you a chance of emulating that
As to your five points, only (1) matters, and this is not true. Net, stock markets withdraw funds from business now
@ lewis
You write ‘“The top 5 contributors in the month were Philip Morris, Pepsico, Johnson & Johnson and Diageo”. These are 4 global corporations that manufacture and market products that are severely detrimental to society and the environment. Is this a factor you take into consideration when making investment decisions? ?
Is this a factor when you invest?
We used to roll out the Boston Consulting Group portfolio analysis and similar. The key problem was that experts were only as reliable as picks by a blind dart-thrower. I have never seen anyone actually able to explain their success in stock-market investment – they roll out what I used to teach as ‘finance for non-financial managers’ (studying Moody’s etc.). I regard the whole of financial services and wealth management as more or less a con. The only predictor I could find on returns was the higher the fees the less the return. Many ‘respectable’ schemes turned out as fraudulent as a Ponzi scam I got to court. Chummy’s defence (early 80’s) was “everyone else was at it, why pick on him”? Quite a few building societies and banks floating belly up down the Thames pleading for a lifeboat more recently look as culpable to me. Of course, I’m a simple man, thinking finance is a cost to be driven down in business by good cash-flow management!
Not keeping all your eggs in one basket sums portfolio management up. That advice is 2% a year and 20% at the end. Ching, ching. Even something as blue-chip as GE now looks ripe for Chapter 11 so what are good and safe stocks? I have no clue these days. Years ago I thought I was investing in skilled engineering at Porsche, though the profits came entirely from its foreign exchange business! Even an old novel ‘Rascal Money’ (1990) is based on what underlies what Richard is saying here, and various dire companies from LA Gear to Enron and US Thrifts, Rover and BHS (is House of Fraser next?) indicate stock prices may be missing the extent of hollowing out. Net loss of companies to the stock-market is very scary as corporate debt hits the roof. The situation looks similar to the days of worrying workers and pensioners were too costly for firms to compete – in the sense of now being burdened with financial costs not connected to investment productivity replacing expensive workers and retired people as the ‘burden’. If stocks can’t outperform gilts the stock-market has no real purpose or expertise.
[…] By Richard Murphy, a chartered accountant and a political economist. He has been described by the Guardian newspaper as an “anti-poverty campaigner and tax expert”. He is Professor of Practice in International Political Economy at City University, London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economy Forum. Originally published at Tax Research UK […]
It sounds to me that picking stocks is like betting on horse at 9/4 when it’s a true 2/1 shot. You are probably going to lose your bet, but the gambler prepared to lose their own money is still going to play.
[…] By Richard Murphy, a chartered accountant and a political economist. He has been described by the Guardian newspaper as an “anti-poverty campaigner and tax expert”. He is Professor of Practice in International Political Economy at City University, London and Director of Tax Research UK. He is a non-executive director of Cambridge Econometrics. He is a member of the Progressive Economy Forum. Originally published at Tax Research UK […]
At some stage someone will do some very hard sums with lots of numbers in them and get their head round figuring-out that most of these market investment schemes are really just zero sum games. If the winner and the losers are far enough apart in time or space it ceases to be obvious and that’s the nature of the ‘trick’.
It wasn’t the original intention, but I think that’s the point we’ve got to, or are fast approaching.
There is a parallel with high street gambling that suggests rather than bet on the horses, investing in the bookie is a better bet. But perhaps not as much fun.
@Nic: Your objection to RM’s Point 1 seems misplaced,to me. The only time that a purchase in the stock market is an investment in a company is when it is for a new issue or a rights issue. Otherwise, it is just everybody’s money chasing round. Just like the house market – the only time you can be said to invest in a house is when it is built for the first time or when you repair / upgrade it, otherwise you are just adding more funds to what is nowadays an already overpriced market.