As more and more investors focus on short term gains, we decided to see how that trend affected the World’s largest capital market and what consequence it could hold in the long run.
Even though stock markets existed for few hundred years, household ownership of stocks surged during the past four decades, as memories of the 1929 crash faded, and a newfound expectation of retirement sparked investment demand. However, for US households owning stocks remained a minority activity for most of the 20th century. It took the advent of the IRA and 401(k) in the late 1970s to change that. 401(k)s, which weren’t in widespread use until the early 1990s, boosted household ownership of stocks to levels that covered a majority of Americans, even after the 2008 financial crisis.
Percent of U.S. Households Owning Publicly Traded Equities or Mutual Funds (%)
However, rising number of investors brought new trends. Just as more people began relying on stocks, the way markets operate and the way we think about stock markets fundamentally changed. At the beginning investing was a longish endeavour where profits accrued slowly over time. Today, the attention is on the here and now, with the average holding period for stocks trading on the NYSE falling from more than seven years to less than one.
Average Holding Period for Stocks by Decade
The current holding period of less than a year is indeed shocking since stocks should be held for a longer period of time in order to achieve a particular goal or earn a high return on one’s investment. This reflects investment transactions driven by both individuals and institutional investors. Until the 1970s, the investment landscape was largely dominated by wealthy individuals and families; this has since changed markedly, with professional investors now accounting for the largest share of investment activity, though it should be noted that these professionals manage significant mutual fund asset pools that are driven by retail investors.
Well, for starters, the abundance of asset management companies to choose from has put severe pressure on managers to generate returns, thus pushing towards a more active investment approach. Furthermore, trading has never been cheaper. Since the formation of the New York Stock Exchange in 1792, it set a firm rule: Trading commissions charged by brokers were to be fixed, and equal among anyone with a seat on the trading floor. It stayed that way for the next 183 years. During that time it cost the same amount per share to trade 100 shares as it did to trade 1,000 or 100,000 — and brokers regularly shaved 2% or more for themselves off the typical trade. That changed in 1975, when commissions were deregulated, and a new free market was set loose. Brokerage commissions plunged overnight, and new discount brokerages came to life.
The Cost of Trading Before and After Commission Regulation (USD)
Cheaper trading resulted in higher liquidity, and with it the ability to exploit short-term market inefficiencies and anomalies also went up. It was too costly in the 1960s to, say, buy Coke stock before earnings with the intention of squeezing a few basis points out of the market’s reaction. The result of deregulating commissions and the ensuring plunge in trading costs was predictable: Trading volume went up. As a percentage of market capitalization, total annual market trading doubled between 1975 and 1983, and then quintupled by 2008.
Effects on the Companies
However, the effects of focusing on the short term came at a cost. Company CEOs are now under increased pressure to deliver favourable short-term result in the company’s quarterly reports rather than focusing on long term growth. Thus, fewer companies are going (and remaining) public, and those that do are waiting longer, in part because there are now better alternatives than the short-term madness of being a public company. According to research from Wellington Management, companies are waiting longer to IPO, stretching on average from 4.6 years after founding to go public from 1990–2001 to 6.5 years from 2002–2015.
Publicly Listed Companies in the US
Those alternatives have downsides, as individual investors now have access to fewer of the economy’s most dynamic and promising companies just at the moment they’re required to invest their own money for retirement. This is clearly seen on the chart above, as one can notice the number of publicly traded U.S. companies peaked in 1996 at 8,090. Today that number has been sliced in half as the number of publicly traded companies amounted to over 4,300. Note that the U.S. population has risen nearly 50% since 1975, and real GDP has tripled. But the number of public companies has declined 15% since 1980.
On the flip side private equity assets have swelled almost sevenfold in the last 15 years, from USD 600bn in 2000 to more than USD 4 trillion today. As a percentage of public-equity market cap, that’s a rise from about 4% to more than 16%. So private equity, all else equal, has captured about twelve percentage points of equity market share over the last 15 years. Trillions of dollars of companies that may have be public 15 years ago are now private. That’s a big deal for individual investors who rely on pubic market returns to drive their retirement accounts.