Remember your first investment in the market? Like you first love, many people recall their first stock purchase. For me, it was Apple Computer, back in 1993, I bought it the same time I bought an Apple Newton (bonus points if you know what that was, even more if you had one). I bought that at the same time I bought Restoration Hardware stock.
I had read that you should buy companies that you like and I am a long-time Apple fan. I had a few extra dollars in hand as my law practice started getting some traction and thought I was being smart. Turns out I was not so smart when I had to sell both a while later because I had not planned for the ebbs and flows of the individual law practice and my own personal economic winter.
Everyone wants to “buy low and sell high”. Few investors can time that appropriately. I certainly did not do that, and shudder to think what that miscalculation cost me. No regrets, all investors have similar stories.
But the message here is, regarding the overall market are we now nearing the point to “sell high”? Just how high is high?
I long ago lost my license to operate a crystal ball; however, I can confidently predict that the future stock market will look nothing like it does currently. What it will look like is a different story, your guess is as good as mine. What it will look like is not the problem, the problem is that most consumers are investing like there will be no change.
Most consumer investors have no education on the market itself. They are sold a story that it is safe and predictable when it is anything but predicable. Sure, the salesmen of the stock market point to the history of the market and its upward trajectory. The consumer is provided with just enough data to trigger greed and confirmation bias. I get it. We want, and many times need, to buy into the narrative about the market and the packaged “diversification” of modern portfolio theory.
What they fail to tell you is that the diversification model of modern portfolio theory is based upon the work of economist Harry Markowitz published in 1952. I won’t go deep into the weeds here but ponder the following question. Is the economy the same in 2024 as it was in 1952? Is the stock market the same now as it was in the years leading up to this research?
Considering just a few ways that the market is fundamentally different than it was in the 1950’s:
Trading was done through brokers, by phone and by hand, not by keystrokes (if not automated).
The US was the undisputed economic leader of the world that had benefitted from investment in manufacturing infrastructure in WWII, not destruction that many global trading partners suffered.
The 401k was first created in 1980 ushering in a new class of consumer investors.
We moved on from adhering to a gold standard limiting monetary growth to a central banking system that creates money in unprecedented amounts.
I could go on and on, but you get the picture.
Here is the picture we don’t have. What will the market look like in the upcoming decade when the 401k generation is relying upon it to provide their income? For many, their savings in the stock market is the fuel for their very survival.
So, what does the stock market of the future look like?
There have been substantial changes since I made my first investment back in 1993. First, we had the dot com bubble, remember that time? The confluence of excitement about this new technology called the internet and the prominence of the 24-hour cable news cycle incorporating coverage of wall street as entertainment led to day trading and Pets.com.
And to market bust.
Which led in part to The Sarbanes-Oxley Act (SOX) intended to protect investors by improving the accuracy and reliability of corporate disclosures. The impact of SOX on companies going public in the United States—specifically, on the number of Initial Public Offerings (IPOs)—has been significant and has evolved over time.
This is a change that is thought by many to be deeply impactful in our current market. In the immediate aftermath of the enactment of SOX, there was a noticeable decline in the rate of companies going public in the United States. The reasons for this included the increased cost of compliance, stricter corporate governance requirements, and more stringent accountability standards for CEOs and CFOs. Many believed these factors made the U.S. public markets less attractive, especially for smaller companies. Statistically the number of IPOs fell significantly in the early 2000s compared to the late 1990s.
Over time, the market has tried to adjust to the requirements of SOX, and the rate of companies going public began to show signs of recovery. This was also facilitated by the Jumpstart Our Business Startups (JOBS) Act of 2012, designed to encourage small business and startup funding by easing securities regulations, thereby counteracting some of the perceived burdens imposed by SOX.
This legislation created a new category called "Emerging Growth Companies" (EGCs) that allowed qualifying companies to enjoy relaxed SOX compliance requirements for up to five years after going public.
Recently, the advent of Special Purpose Acquisition Companies (SPACs) as an alternative path to going public has also influenced the number of public listings. SPACs have become a popular mechanism for companies to go public, particularly in 2020 and 2021, contributing to a surge in public listings during those years.
So what he now have is a smaller pool of publicly traded companies into which our 401k savings is predominately invested, with just a handful of companies driving the market return.
The following chart from the St. Louis Fed shows the dramatic reduction in the number of publicly traded companies.
At the same time, the ratio of stock market capitalization to Gross Domestic Product (GDP) is at an all-time high.
So, where does all of this lead us? The printed money has found a home in the publicly traded markets and predominantly in a few select companies (the Magnificent Seven). What other money has found its way into the publicly traded markets? Your money and your client’s money. What I call the consumer investing class.
What money is finding the way out of the publicly traded markets? The money of the wealthy, the accredited investors that can diversify with private equity investments, real estate, collectible’s, bitcoin, etc. They can afford true diversification while the consumer investing class is drawn to less diversification as they panic and look for return to keep pace with inflation.
Which brings me back to my first love, Apple. A prominent member of the Magnificent Seven and a child of the 401k era. A company that, along with other tech sector that created a narrative of growth. Smart people working hard, bootstrapping together a company built upon serving new needs, providing new value to the marketplace. Sooner or later, they go public creating massive wealth for the founders and investors.
Now it is more likely that that story ends with a private equity investment and the proverbial rich getting richer. Where does the next wave of market leaders come from?
So, will Apple be a market leader in the future market? Again, I have no idea, but history does tell us that most market leaders have a short lifespan in that role. Apple now finds itself in the role of Defendant in a recent lawsuit filed by the Department of Justice and 16 state and districts attorneys general. Google finds themselves in a similar situation.
When the government has you as its trust-busting target it can end badly for market valuation. You need look no further than 1999-2001 for the Microsoft Case. As for Apple, Bell Telephone comes to mind. That 8-year lawsuit ended with the dismantling of that centuries old company into the “Baby Bells.”
We could write similar stories for each of the Magnificent Seven and other current market leaders.
So, what does this mean to you and your clients? At a minimum, tremendous change is likely, and the investing strategy needs to take this into account. We have unprecedented consolidation and concentration of wealth in just a handful of entities. Wealth that can be wiped out in what will appear to be the blink of an eye.
We can build a bridge to protect our clients against this event, but they need to understand the risk they face.