What’s the point of a stock market?
I suppose it works because it’s so many different things to so many different people…
Savers can deploy and grow their capital instead of keeping their money at the bank.
Investors can diversify easily, cheaply and quickly.
Executives with stock options can grow rich from performing well.
Investment bankers can grow rich from mucking about in the market.
Stockbrokers can grow rich helping other people muck about in the market.
Traders can snipe profits from prices going up and down.
Private company founders can list their unicorn company in order to become a billionaire.
Fund managers can grow rich sitting on your money.
So the stock market is hopefully a giant win-win. Wonderful, isn’t it?
But what about companies raising capital to grow their business?
That’s been lost in all the trading fervour…
The primary market has become
a secondary issue
The stock market as you know it is known as a secondary market. Shareholders can buy and sell existing shares. This exchanges ownership. But it doesn’t increase anything of value. It’s a zero-sum game, less the fees.
The primary market is where shares are created. Issuing shares onto the stock market raises money for companies. It transfers investor’s cash to the company. The idea is that managers will deploy that money in ways which grow the value of the business. This creates value…if they get it right.
A mining exploration company might issue shares to fund the development of its mine.
A retailer might issue shares to launch its overseas business.
A biotech company might issue shares to fund research and development.
A bank might issue shares to expand its branch and ATM network.
Just kidding.
The point is, something of value is being created in the primary market. Not quite out of nothing. But without the shares being listed, the thing of value wouldn’t eventuate.
To simplify, the primary market creates value. The secondary is a casino.
The parasite is really a symbiote
The twist in the tale is that you need a secondary market for the primary market to function. What looks like a parasite is really a symbiosis – they only survive together.
That’s the realisation which the Dutch and British figured out, helping them create their commercial empires 300 years ago.
Plenty of governments issued bonds to investors to fund themselves back then. But it was usually hard to sell them. A bit like bitcoin in its early days, before exchanges. People used chat rooms and met in parks to exchange their crypto.
If people cannot sell their investments quickly and cheaply for a fair market price, they don’t invest as much in the first place.
And the price of an investment that is easy to sell will be far higher because sell-ability has value. The pros call it “liquidity”.
So, if you create an exchange that provides liquidity. And then you get more investors putting in more of their money at higher prices overall.
This realisation created the bond markets which defeated French emperors, the Spanish Armada, won World War I and II, and the Cold War.
Anglophone countries were able to raise more money at higher prices (lower bond yields) and thereby grab more resources because they had exchanges. And they say debt is a bad thing…
But it’s not just totalitarian regimes you can defeat with decent financial markets. You can also advance the technologies that make us better off.
The link between stock markets and
tech gadgets is profound
Why does America have all the tech companies?
The answer is their financial markets. They can help develop a firm from startup to global behemoth better than anywhere else. Cheaper, faster and bigger.
It used to be London’s business. Back in the days of Exchange Alley and coffee houses. The steam engine, whaling and the slave trade grew out of these institutions.
But now New York is the place to go if you have money or if you have an idea. Both groups know they’ll be welcomed and find each other there.
The overall effect is to bring technological change into the real world at an extraordinary pace.
Other countries’ financial market’s primary stock market listings are drying up.
This issue is masked by our obsession with the performance of stocks that already listed years ago. We care about their prices instead of how much money was raised by companies that need it to invest.
Ironically, nothing is worse for blue chip companies than a steady stream of more technologically advanced competition from the ranks of smaller companies. And the stock market really exists for those small companies to raise the capital they need to compete.
Economists call this ‘creative destruction’. Economies grow by a process of ‘out with the old and in with the new’. Passive investing in the ASX200’s blue chips isn’t exactly congruent with that interpretation.
But what I’m trying to say is that share listings and capital raisings are the real measure of future prosperity. Not the price performance of stocks.
Instead of the news reporting on the value of the stock market index each day, it should report how many companies listed on the stock exchange and what they did with the money.
“Today, investors in stocks funded new factories in Gippsland, new power plants in Cairns and a toy factory in Noosa,” sort of thing.
If they did mention the actual data, it wouldn’t be a good news story. Initial Public Offerings — when stocks first list — are at financial crisis levels in Australia and globally.
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| Source: ASX |
Even worse, IPOs have become an exit strategy rather than a capital raising venture. Mature private companies list their shares in order for owners to sell out at prices they couldn’t achieve outside the stock market.
This doesn’t raise capital, grow wealth or develop tech.
We often hear that productivity growth is the key to prosperity. Well, the primary market part of the stock market’s purpose is signalling we’re not in for much productivity growth. Unless, of course, AI bursts onto the scene with a bang.
The good news is that we’re bringing back the stock market’s true purpose. A place where you can aim to grow your wealth in a way that aligns with growing companies and rolling out breakthrough technologies that radically improve our future.
Regards,
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Nick Hubble,
Editor, Strategic Intelligence Australia
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