After The Stock Market

Felix Salmon offers the quick upshot of his excellent article on the robotic overlords of Wall Street:

Firstly, there are millions of individual investors doing diligent homework on companies and trying to invest intelligently in the stock market. When they finally arrive at a conclusion and the time comes to buy or sell, their collective decisions are known politely as “retail order flow,” and less politely as “dumb money”; high-frequency trading shops make lots of money by paying for the privilege of filling those orders and taking the opposite side of those trades.

It’s possible that one individual investor — Mr Iyer himself, perhaps — can beat the odds and make more money on his own than he would do simply investing in an index fund. If he does, then it might be due to luck, and it might be due to skill. But if I know nothing about Mr Iyer except for the fact that he’s a retail investor looking at corporate fundamentals, I wouldn’t give him much of a chance of beating the market. Fundamentals-based investing is (still) a very crowded trade, and most people who try it fail — they get picked off by faster, smarter, more sophisticated players in the market.

It seems to me there’s this kind of lurking bug in capitalism. The whole system relies, more or less, on a steady supply of suckers. But the system is, overall, a good one. Some people have good ideas about business expansion and some people have money. Those generally aren’t the same people. So fortunately, growing firms are able to sell shares to raise funds. And since there’s a secondary market, it’s possible to make money buying those shares. So firms can raise funds and expand. Keynes said long ago that it seems unwise for investment decisions to be the byproduct of a casino, but for all its flaws the system has trundled on for 70 more years.

But at the same time, the domination of the economy by publicly traded firms with shares listed on highly liquid markets is something that happened in historical times. And one could imagine it ending. Justin Fox wrote recently that firms are increasingly inclined to stay “private” as long as they can not to evade the dread Sarbanes-Oxley but because of excessive liquidity.

As best I can tell, the trends point in the direction of smart potential retail investors realizing they don’t want to take their life savings to the casino, leading to a stock market that’s ever-more-dominated by suckers and algorithms. That, in turn, means entrepreneurs will be ever-less-inclined to turn ownership of their firms over to the market. That creates a demand for more innovative ways to let larger groups of people invest in private firms, which should further drain the public market of “smart” money. And at some point the era of the publicly traded firm’s hegemony may come to look like an aberration.