The way that share prices bounced back after October's falls showed that modern business has got more money than balls, argues Phil Mullan
What goes down, goes back up again
What surprised the experts in late October was not the nose-dive in share prices, but how quickly the markets recovered. Almost everybody had been predicting a fall on the New York and London exchanges for months; share prices were 'overvalued', inviting at least a 'correction', a 10 per cent fall in prices, if not a full blown crash - a loss of 20 per cent plus. Also it was coming around to October again, as tends to happen about once a year. And October is the time for stock market collapses: 1929, 1987, 1989, 1997?
Yet no sooner had the long expected share price falls happened, than equally rapid gains followed. The largest ever one day index fall on Wall Street on Monday 27 October was succeeded the next day by the largest ever daily rise. Since then most Western stock markets have regained the upward trend.
So why didn't the roof fall in on the financial world? Many claimed that, contrary to earlier doubts, it must mean that the American and British economies really were in good shape after all. The 'fundamentals', by which is meant favourable conditions of steady, sustainable economic growth, rising productivity and low inflation, were declared sound. The Bank of England even put up interest rates again to prove its anti-inflationary zeal in the face of a supposedly overheating British economy.
Investors' faith in shares, ownership of which provides a claim on future profits, was interpreted as a sign of confidence in the real economy. And since bull (rising) markets are often seen to be driven by a healthy 'appetite for risk', explained Peter Martin in the Financial Times, the conclusion should be that the entrepreneurial spirit is also alive and kicking.
Not quite. The real forces which have sustained steadily rising share prices for 15 years derive not from the underlying strengths of the US and British economies, but from their long-term weakness. And far from being a sign of risk-taking entrepreneurship, today's high stock markets reveal a safety-first spirit of risk aversion and taking precautions.
So what happened to reverse the price falls of 27 October? The mechanics of stock market movements are driven by supply and demand. When demand is consistently in excess of the supply of new shares, share prices will tend to rise. When demand exceeds supply by a fair margin, prices will rise fast. The demand side comes from the mass of money buying shares.
On Tuesday 28 October, a 'wall of cash' came in to push the markets back up again. Small investors came into the market, both directly and indirectly through investment funds: pension funds, investment trusts and unit trusts, or mutual funds as they are known in the USA. At the same time IBM, one of America's largest public companies, announced a $3.5 billion buyback of its own shares, starting rumours of other big buybacks to come.
These were dramatic and unexpected developments, yet they were also in line with recent trends. The key upward influence on share prices in the 1990s is the high level of liquidity - the technical term for the weight of money washing around the economy. This spare cash is going into buying shares and pushing up prices.
Much of the cash comes from the explosive growth of personal savings in equity funds. In America the net inflow into these funds has risen from $10 billion a year in the mid-1980s, to $50 billion in 1991, to well over $200 billion in the past couple of years. People are putting more and more money into pensions and other forms of savings for retirement; 84 per cent of the 40 million American baby boomers investing in the mutual funds say that retirement saving is their main goal. Widespread concern about old age is fuelling this flow of funds into the markets.
British pension fund assets have also grown rapidly, from about $600 billion in 1990 to nearly $800 billion in 1995 with forecasts of over $1200 billion by the Millennium. Globally, total pension fund assets are projected to grow from $5 trillion in 1990 to over $12 trillion in 2000. All the evidence suggests that this trend looks set to accelerate.
Far from rising stockmarkets providing evidence of a risk-taking culture, then, from the demand side it is the culture of fear of the future that is driving markets up.
The same risk aversion is evident on the part of business, as reflected in the big IBM buyback. The corporate world creates the supply side influence upon stock prices, as companies issue shares to raise capital. Yet companies are today issuing fewer shares than 10 years ago in the heady days of the late 1980s. Few seem keen to go out to raise new share capital for expansion. This limits the supply of shares and ensures that the huge amounts of money available go into bidding up the price of previously issued shares. Hence the bull markets.
The business world's reluctance to raise new share capital for investment seems strange, given the apparently strong growth in profits. Corporate America has reported double digit increases in quarterly earnings for the past six years. Britain PLC has not been far behind. Tax cuts, lower interest rates, cost cutting, downsizing, the intensification of work, have all contributed to rising profits. When profitability is high, why is the money not being raised to fund productive investment in the real economy? If the fundamentals of Western economies were as sound as is supposed, why are companies not investing heavily in the future?
The fact is that investment is at historically low levels across most of the industrialised world. Snapshot pictures of the advanced economies might show above average rates of growth, double digit rises in investment levels, and accelerating productivity growth. But the longer term picture tells a different story. International Monetary Fund figures show investment in the advanced industrialised economies has fallen from 25 per cent of Gross Domestic Product in 1973, to 21 per cent in 1985, to about 20 per cent in the mid-1990s. In Britain the position is worse, falling from about 20 per cent in the 1970s to just over 16 percent in the 1990s.
Since productive investment is an economy's dynamo, it is not surprising that all the major economies are experiencing long-term slowdowns. OECD figures reveal that in each of the USA, Japan, Britain and the European Union, the average annual growth in national output and productivity has been lower in the 1990s than in the 1980s. The eighties rates were already considerably lower than in the boom years of the 1950s and 1960s.
If the fundamentals are not as healthy as we have been led to believe, then why are companies not taking advantage of rising profit rates to make the productive investments that could reverse the trend? What is holding business back from putting its cash, and other people's money, back into industry?
Two of the more critical economic commentators - Doug Henwood from the American Left Business Observer and John Kay from Oxford University's new Business School - have both pointed out that, over the past 20 years, stockmarkets have no longer been approached by business as a source of funds. Far from turning to the markets for finance, companies have been pouring money into the markets - buying back their own shares and taking over other businesses through mergers and acquisitions. The consequence is that in the main Western stockmarkets more stock has been 'retired' than issued. Henwood estimates the level of payback at over $800 billion in the USA since the early 1980s. 'Surreally', as he notes, the stock market has become a negative source of funds. Some risk-taking!
Rising profits in Britain and America have not modified the trend. All that has changed is that, instead of borrowing money to fund stock buybacks and takeovers, companies are using their own profits to finance even more buybacks and record levels of takeovers. Huge corporate cash balances are also financing record dividend pay-outs to shareholders.
Capitalism used to be about making profit in order to accumulate and so make more profit. Today when they have profits the instinct of modern capitalists seems to be to get rid of them. The well-publicised philanthropic gestures by CNN's Ted Turner ($1 billion donation to the UN) and the global speculator George Soros can be seen as part of a broader trend. Profits are no longer being used to invest and accumulate but to fund handouts. Instead of seeking funds from the money markets, capitalists are more keen to shovel money into their shareholders' pockets.
The problem is that, if capitalism has lost its nerve in investing for the future, we will all suffer the consequences. The productive forces will go on stagnating, as stricter limits are imposed on investment, experimentation and development.
A hundred years ago, robber barons like Rockefeller, Carnegie and J P Morgan personified risk-taking to make money for themselves. In the process they financed technological breakthroughs in the use of telegraphy, telephony, transportation and electricity which benefited all of humanity. Being confronted with today's gutless breed of capitalist almost makes me nostalgic.
Reproduced from LM issue 106, December 1997/January 1998