The first thing the media do when reporting on any significant financial news is to tell us what effect it has had on the stock market. This used to seem intuitively reasonable to me. I always figured that stocks represented the health of the economy, so that if they were going up, this was a good thing. I now don’t think that. It’s not because I’m some loony lefty praying daily for the demise of the capitalist system, it’s because I’ve had some time to think about what stocks are and what their performance reflects.
The First consideration is how value is determined. A stock basically confers a right to dividends (the cash that the company’s management decides to give out to shareholders), as well as an ownership share of a business’s capital – ie, if the business got sold, you’d get your share of the cash. However, people don’t know what the future dividends are going to be because the future is unknowable, so they have to rely on signals. One of the best signals is current dividends, on the basis that the future is pretty random. Therefore, companies that do things that maximise short term dividends can raise their share prices – but cause economic harm. An obvious example would be returning cash to shareholders rather than investing in staff training. Or selling off the company’s physical capital. This is a fairly standard complaint you hear on the left.
The Second thing to think about is scope. Owning a stock means that you own a tiny part of a publicly listed company. Not all companies are publicly listed. The vast majority are privately owned, and ownership in them is not for sale. If they represent economic activity, stocks represent only a fraction of the total, so the most stock prices can possibly be telling us relates to activity in the part of the economy that is made up by listed companies. Is this the most interesting part of the economy? Well not for most people. Most people are not employed by listed companies, but either work for themselves or a small business. Therefore, even if stocks are rising in price because the companies are actually doing something of value, it’s only a fraction of the economy and a fraction which has little bearing on most people’s welfare. Admittedly, one would expect it to be highly correlated with the rest of the economy, except when it isn’t!
The Third thing to think about is the relationship of the sector of the economy with access to capital markets with the sector that doesn’t. By definition, listed companies have access to capital markets, that’s what being listed means. They therefore have access to financing, and use it actively. They are fundamentally different kinds of institutions to those without – they are based around configurations of capital, rather than non listed companies and individuals which are configurations of labour. In the financial crises, when the supply of bank credit fell, the ‘unlisted’ sector of the economy was starved of purchasing power even as record low interest rates and the hunt for yield allowed companies plentiful credit from the capital markets.
It’s fully possible for listed companies to thrive, accumulate plentiful cash piles, and increase their share prices as the wider economy falters. A combination of these three mechanisms explains this – companies pursue short termist actions that are not economically optimal, and even if they are they only positively affect a minority, which may not be correlated and may in fact be pulling the opposite way to the rest of the economy. So why are the media so obsessed with stock prices? Well, they’re measurable, they’re widely advertised, and their going up favours the capital owning elite – with whom the media is often touchingly sympathetic! Stocks going up need not and often does not reflect an improving economy or a better society. Sometimes stocks go up because its good, but it need not be good for stocks to go up.