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POLITICAL ECONOMY
Outside View: Are stocks a sucker's bet?
by Peter Morici
College Park, Md. (UPI) Jan 28, 2013


disclaimer: image is for illustration purposes only

With corporate profits at record levels and stocks regaining the ground lost during the financial crisis, Wall Street anxiously anticipates the return of the individual investors to equity markets.

It may be a long wait because the little guy may have concluded stocks are a sucker's bet.

Investors, as opposed to traders, buy stocks in companies whose profits they expect to rise. The conventional wisdom says stock prices will follow profits up but over the last two business cycles, that simply hasn't happened.

In March 2000, the Standard and Poor's 500 first closed at more than 1,500. Since corporate profits are up 135 percent but stocks have made virtually no gain since over the last 13 years.

Buying stocks doesn't seem to pay any more because most of the increased value created by higher profits has been captured by hedge funds, electronic traders, private equity funds, aggressive M&A shops and trading desks at investment banks, which have multiplied over the last two decades.

Their activities, essentially, fall into two categories: Aggressive trading -- e.g., exploiting complex shorting opportunities, quickly detecting and exploiting movements in trading intentions of large mutual funds and other tactics often associated with exotic hedged bets and electronic trading; and direct asset purchases -- buying underperforming companies, all or in part, to force managers to pay out large sums, rearrange their companies through mergers and divestitures or exploit unattended business opportunities incumbent managers have been lazy about pursuing.

Not all of this is negative to stock prices or unfair.

Shrewdly synthesizing public information to identify value in companies ahead of other investors is the way stars like Warren Buffet became legends. Stock prices rise permanently in wake of their actions and that's good for the ordinary investor already in the stocks they pick.

Shaping up underperforming companies likely started even before the first Greek shippers bought out rivals to discharge incompetent captains and reduce seafaring risk, spread overhead and accomplish more leverage with potters, weavers, farmers and foreign merchants.

Nevertheless, too much of a good thing -- electronic trading and aggressive hedging -- can be disruptive and impose unnecessary risks. Look at the costs imposed by the May 2010 Flash Crash and consider how private equity firms and M&A shops acquire companies and load up them with debt, make big payouts to dealmakers and then later disappoint investors and creditors.

Through superior information, quick execution and aggressive marketing, traders and dealmakers capture a great deal of the potential increase in value created by new and anticipated corporate profits before that value is recognized in stock prices. This results in lavish compensation for traders and dealmakers and stock prices that don't rise with profits.

Instead of ordinary folks getting a decent return in their IRAs -- in line with the rise in corporate profits -- real estate prices in the Hamptons and luxury goods sales at Manhattan's finest stores soar.

Hedge funds, electronic traders, private equity and M&A shops do act on information that is obtained through careful, legitimate research but the ordinary investor simply doesn't have the resources to compete with those efforts.

Moreover, as several SEC investigations into insider trading indicate, critical competitive information is sometimes obtained through unethical and illegal means -- data pried from incautious corporate officials and through electronic espionage further disadvantages opportunities for gains by individual investors and conventional mutual and pension funds.

The ordinary investors are simply outgunned. For him stocks have become a rigged game.

(Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, and widely published columnist. Follow him on Twitter: @pmorici1.)

(United Press International's "Outside View" commentaries are written by outside contributors who specialize in a variety of important issues. The views expressed do not necessarily reflect those of United Press International. In the interests of creating an open forum, original submissions are invited.)

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