What is the point of an equity market? Ask strategist Russell Napier and he will compare it to a large hole in the ground at Nendrum on Mahee Island in County Down. For many years, a sign was posted next to it saying “Pit of Uncertain Use”. It exists and people pay a lot of attention to it, but its original purpose is lost. That about sums it up, he says.
Anyone landing from Mars in the past ten days would think that harsh. They would be sure that the stockmarket has a very certain purpose: to allow large and established companies to get larger still by merging with each other. This makes sense as an interpretation. Last week a dozen takeover deals, each worth more than $100m, were announced in 24 hours; several had values well into the billions, bringing the total to more than $120bn: Sainsbury’s and Asda; T-Mobile and Sprint; Marathon Petroleum and Andeavor.
These mergers are not bad in themselves (although, more often than not, deals of this scale at this point in a global cycle end badly). Shareholders have made money and consumers may well find the consolidation feeds through to lower prices. That is nice – as the chief executive of Sainsbury’s made clear when he was filmed singing “We’re the Money” while waiting to be interviewed on his deal. But the scale of this shifting around of shares leaves investors with the nagging feeling that, despite the frantically high levels of activity, we are not getting anywhere. And we are not.
Stockmarkets should be more exciting than this
Stockmarkets should not be about the endless pursuit of cost savings and market share via acquisition and consolidation. Their real point, historically at least, should be something much more exciting: the funnelling of cash earned from the productive activity (work) of ordinary investors into the financing of new productive activity that will boost economies and make everyone better off in the long run.
Market commentator Humphrey B Neill summed this up nicely in 1931 when he was trying to persuade his shell-shocked readers, many of them facing life-changing losses from the great crash two years earlier, not to abandon investing altogether. Were it not for the cash-funnelling effects of the stockmarket, he said, “America would not stand where she does, as the leading industrial country in the world. We may deplore speculation, but if it were not for this outpouring of money for stocks, you and I should not enjoy a fraction of the comforts and luxuries which we accept as necessities.”
The problem today is that there is not enough of the kind of speculation Neill had in mind. Cheap money has made it far cheaper and easier for companies to borrow and buy other companies, to borrow and buy back shares, and to borrow and pay dividends than to attempt to create value via the laborious path of increasing productivity and organic growth.
Over the past 50-odd years, consultant McKinsey estimates that US companies have returned about 60% of their earnings to shareholders. In 2015, 2016 and early 2017, that rose to more than 100%. There is also the private equity industry, and its eagerness to buy pretty much anything on offer, to consider – private equity had $1.8trn of “dry powder” to spend at the beginning of 2018. So capital that could have been used for productive investment is increasingly taken out of the market.
This attitude represents a dangerous short-termism
Modern investors mostly think this is OK: they are ageing, scared of risk and they cannot get the income they need from bonds, because of low interest rates. So what is wrong with putting money into companies that, as economist Dambisa Moyo puts it in her new book The Edge of Chaos, “harvest cash flows today rather than investing in companies to grow tomorrow”? In the short term, the answer is maybe not so much; in the long term, an awful lot.
This attitude exaggerates the trend to oligopoly and represents a dangerous short-termism, If most people opt to invest in such a way that they are effectively buying income from past productive investments, who is left to put money into a newly productive future? It can also exacerbate wealth inequality.
Investing in real growth has the potential to make investors proper money. But sit around the table of any advanced startup company these days and you will not hear them planning the run-up to an exciting initial public offering (IPO) with a view to financing their next stage of growth. Instead you will hear them talking about which private-equity firm will make the best “partner”. That means the companies that do make it to IPO are the ones that are too long-term or too uncertain for private equity – speculative investments in the bad sense rather than Neill’s sense. Think Tesla and biotech.
This is not shareholder capitalism as it should be. It is circular, uninspiring and, to the ordinary person who does not get access to the good stuff, rather alienating. And if it does not start to change soon, what will we have when all the mergers are done? Not the wealth and equality-creating machine we want. Just a lot of big, expensive companies sitting in a pit of very uncertain value.
This article was first published in the Financial Times.