'The stock market is for suckers'
January 24, 2011 | Jason Kirby | Maclean's | LINK
The stock market has become dangerously disconnected from its primary function of uniting growing businesses with large numbers of long-term investors. [...] Markets have come to be dominated by myopic short-term thinking. The vast bulk of trades now involve no humans at all, but rather sophisticated computer programs that swap stocks at lightning speed; many believe so-called high-frequency trading was one of the causes of the flash crash last year that exposed how fragile the whole game has become.
“The idea of the stock market was to help businesses raise capital, and to provide people, individuals, with a chance to invest their savings and participate in that growth and have enough money to retire,” says Peter Cohan, president of Peter S. Cohan and Associates, a venture capital and management consulting firm in Marlborough, Mass. “But in the last decade the whole thing seems to have fallen apart.” Where the market once helped investors and companies, now it’s failing both.
In 2004, at the age of 92, the late Sir John Templeton, a pioneer in the world of mutual funds, issued a stark warning to investors. “The stock market is broken,” he said in an interview. He went on to predict the housing bubble would spark the sort of terrible market crash we witnessed four years later. But Templeton saw a bigger problem than just the bubble then emerging. Stock markets are now dangerously short-sighted. “Mass media, especially TV today, is so short-term that few in its audience grasp the lasting damage and corrective impact which will continue to linger from the greatest financial crash in world history,”
he said. In the wake of that very crash, short-term thinking is as much a problem as ever before.
The stats behind investors’ amputated attention spans are astonishing, and reveal the damage caused to the wider economy. According to the New York Stock Exchange, in the 1960s the holding period for stocks was eight years. By 1990 it had fallen to two years and today the average stock is held for just nine months.
As investors have shortened their time horizons, companies have been focused on each next quarter’s financial results at the expense of the next decade, say experts. Last spring, the U.S. Senate banking committee held hearings to examine the plague of short-term thinking in capital markets. Some astonishing revelations emerged. In a survey of 400 chief ﬁnancial ofﬁcers, 80 per cent said they’d cut research and development spending to goose short-term performance. To make matters worse, when companies do beat expectations, executives are lavished with huge paycheques and millions of stock options that dilute existing shareholders even further.
One reason investor time horizons have shrunk so dramatically is that hedge funds have been taking massive gambles using borrowed money, says Cohan. “One of the biggest sources of volatility is hedge funds betting on very short-term movements,” he says. “That whole dynamic is not really conducive to long-term investing, or the long-term management of companies.”
The same can be said for much of what goes on in the stock market these days. At precisely 2:45 on May 6, 2010, U.S. indices plunged nine per cent, temporarily wiping out US$1 trillion of market value, before recovering several minutes later. For many regular investors, it was their first painful introduction to the volatile world of high-frequency trading. HFT firms earn billions betting on stocks as they move up and down by fractions of a penny. A typical high-frequency trader owns a stock for just nine seconds. The problem is, should markets drop abruptly, the complex computer algorithms used by HFT firms can make matters worse.