A client recently asked for my thoughts on an article from New York Times Magazine titled, “How the Stock Market is Failing America.” It starts with this premise:
The market is doing a terrible job of allocating capital for economic growth, said Michael Steinberger in The New York Times Magazine—but a really good one of funneling wealth back to the richest investors.
In the article, the writer, who admits “no particular financial expertise,” is clearly perplexed by the massive rebound rally that started in March even in the “face of a global pandemic and what’s shaping up to be the worst economic downturn since the Great Depression.” He called it “jarring” to watch and “macabre.”
But it wasn’t just the recent stock rebound the writer was talking about, citing pre-coronavirus trends that cast doubt on whether the market was facilitating economic growth. Those who benefited the most from the run-up, he claims, were wealthy Americans who are best positioned to ride out this crisis. The question he poses is whether “the market is detached from reality, or does it simply reflect the reality of those most heavily invested in it?”
What is the Purpose of the Stock Market?
First, let me address his personification of “the market,” which is simplistic and sophomoric. As someone who has been college-educated, industry-trained, and an active participant in the securities markets for more than 26 years, I can assure the writers and editors that there is no one behind a green curtain pulling the levers of capital allocation. In fact, capital is allocated every minute in an incredible way by hundreds of millions of market participants—quite the opposite of what the article suggests.
The purpose of the stock market is to provide an environment whereby investors can efficiently allocate capital to the most productive and attractive companies, as well as providing a means to invest in the “up-and-comings” of tomorrow, essentially tomorrow’s headliners. This is what spurs competition and innovation, ultimately fueling economic growth.
Why the Stock Market is Often Detached from Today’s Reality
Another notable miss from the aforementioned author’s comments is the very forward-looking nature of the market. This is a fundamental principle of the market. Investors aren’t investing for today, next week, or next month. They’re investing for the next year or two and the earnings they expect companies to generate.
If we are in the midst of a V- or U-shaped economic recovery, investors are looking to the upside of the V or U. Also, in times like these, companies with structural impairments are revealed, while companies with excellent management and strong balance sheets go on to prosper.
Who Really Controls the Stock Market?
A handful of wealthy investors or institutions have no control over which companies die and which ones survive, let alone what companies will be earning in a year or two. Therefore, the notion that capital allocation is “funneling wealth” indicates that this article is not about capital allocation in an investment sense. Instead, it reveals the writer’s “robin hood” mentality surrounding the undeserving “wealthy” who have too much money. That is more of a public policy issue related to taxation, public revenues, and the role of government.
Although specific public policies can influence the countless decisions of the millions of market participants, there is no unified approach to their decision-making. On the contrary, they make decisions for allocating capital for their own reasons. Many want to provide a college education for their children or achieve a financially secure retirement. Many decisions are irrational, driven by fear or greed. These are all capital allocation decisions, but the participants don’t see it that way. To them, it’s just living life.
While there are arguments to be made that investment capital returns (dividends, return on equity, etc.) are too high, and human capital returns (wages) are too low, those can be debated in the public square and among policymakers. For the rest of us mere market participants, we need to continue to “allocate capital” by living our lives with the best wisdom we can and making full use of the freedom we have.