Hollow Capitalism

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Until very recently — mid- to late-July, to be exact — American and European stock markets were marching steadily higher. In many cases, new all-time-high levels were being achieved with monotonous regularity.

Yet a closer examination of the trading activity on many of these markets revealed a much less rosy picture. First, not all stocks were still rising. Indeed, by mid-year, MOST stocks in the US were falling, not rising, and many were significantly (i.e. 10% or more) below their highs for the year. Drilling further down revealed that, over time, fewer and fewer shares were taking part in the ongoing rally — but these were the largest companies, meaning the ones with the largest market capitalization. A few big, broad-shouldered behemoths were effectively carrying the whole market upwards.

This narrowing phenomenon was even more apparent with regard to trading volumes. Although volumes have been shrinking throughout the long bull-market (or bear market correction, as others view it) underway since March 2009, the trend has been severely exacerbated in 2014. Overall, as the markets rose, trading volumes shriveled — an unhealthy phenomenon and, in essence, a vote of no confidence in the market on the part of the investment community.

But the most dramatic element in the poisonous brew that global equity markets had become by 2014 was the identity of the buyers. After all, for prices to rise there must be more buyers than sellers. Who was doing this buying? The answer, it transpired, was the traded companies themselves. Share buybacks soared in the boom years before 2007 and then dried up, to negligible levels, during the slump. They then climbed steadily higher, reaching new records in the first and second quarters of 2014, and making the companies the key to pushing their share prices higher. The most prominent actors in this farce were the biggest boys on the block — Apple, IBM and their ilk.

Why is it a farce? Because all normal investors try — even if most do not succeed — to buy low and sell high. Corporations, as just noted, have consistently bought their shares when their prices were at or near their highs, but have shied away from doing so when their share prices slumped.

Why do they behave in this counter-intuitive manner? Because they use borrowed money to do the buying. In a boom, especially the current zero-interest environment, banks and the bond markets are eager to lend big-name corporations money. In a crash, the willingness disappears and the spigots dry up — leaving the borrower devalued assets against its debt.

But that is the technical aspect of share buybacks. The deeper ‘why’ is why do corporations act in a way that most individual investors would deem irrational. It turns out that corporate managements are exceedingly rational. They buy their companies’ own shares to reduce the number of shares outstanding, thereby increasing the amount of profit per share and justify their bonuses — and also, critically, increasing the value of their own shares or options, awarded to them for their ‘success’.

However, whilst lining their own pockets, corporate managements are failing to invest in new plant and equipment — the genuine economic, as opposed to speculative, investment open to them — or even to pay their workers more. They thereby undermine the macro-economy by reducing investment and/or constraining private consumption.
This state of affairs led Professor Joseph Steiglitz, one of the most prominent academic critics of Wall Street, to note in early July that “these very strong stock market prices are in a sense a symptom of the weak economy, not a symptom that we are about to have a strong recovery to our real economy”. That’s because to have a real recovery that would generate genuine economic strength, you have to have more jobs — whereas, he noted, the workforce has shrunk sharply — and higher real wages paid to those employees. But that’s not what’s happened in the US (let alone Europe or Japan). Instead, Steiglitz noted, “In the United States, from 2009 to 2012, 95 percent of the gains went to the upper 1 percent. Ordinary Americans are using up their savings.”
In sum, by July 2014, the equity markets were a total sham. The main share indices were rising thanks to big companies taking on debt and wasting that money buying their own over-priced shares — because they had nothing else better to do with (other people’s) money and because that ensured that the fat cats would get much richer, at the expense of everyone else.
Unsurprisingly, fewer and fewer people want to participate in that kind of ‘market’, at least as buyers. When an excuse arrived — in the form of rising geopolitical tensions, poor economic data, or ‘whatever’ — the sellers gained the upper hand. Significantly, the onset of selling in late July saw volumes rise and prices fall across the board. This may have been the initial stages of a much bigger and prolonged decline. But whenever the crash comes, it will be the implosion of a rotten structure which has already been hollowed out. A fair and functioning market long since left the building.