Thursday, December 17, 2009

"Stock-Renters"

"...we have this huge amount of investors in the market or, rent-a-stock, stock-renters in the market compared to stock owners." - John Bogle on CNBC

Yesterday morning on CNBC, John Bogle referred to the following quote from John Maynard Keynes:

"Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done." - John Maynard Keynes in Chapter 12 of The General Theory of Employment, Interest and Money

Bogle went on to say that one of the biggest risks going forward is what he sees as the unfortunate, and in his view very damaging triumph of speculation over investing. In the video, he goes on to say that the problem is the ongoing trend toward speculators in the market (what he calls the "stock-renters") and away from owners with long-term returns in mind (Bogle points out that the amount of speculative activity is measurably higher now than it was even in 1929).

To me, it makes sense that you end up with more price distortions in the market like we've had this past decade with so many "renters" participating. An owner of something is more likely to be grounded by intrinsic value. A renter will naturally focus on short term price movement even if that price is extremely decoupled from reality.

"Long ago, Ben Graham taught me that 'Price is what you pay; value is what you get.'"  - Warren Buffett in the 2008 Berkshire Hathaway Shareholder Letter

If a larger and larger percent of market participants are not grounded in value, and instead focused on price action, doesn't it seem probable that the result will be more stocks becoming mispriced relative to intrinsic value? Would GE and Coca Cola have been selling at 50+ times earnings in the late 90's or Cisco at 100x during the internet bubble (never mind all the internet bubble stocks that made even Cisco at 100x earnings look cheap) if fewer participants were in the "stock-renting" business?

The emergence of the market technicians could be seen as cause or symptom depending on your point of view. Either way, technicians do not see any point to fundamental analysis. It's all in the charts (technical analysis is not new but it is certainly prevalent). Algorithms that are designed to profit from "ownership" of a stock for mere seconds care nothing about value. With fewer participants focused upon value the frequent and widespread mispricing of assets seems inevitable.

In Bogle's book, The Battle for the Soul of Capitalism, he said the following:

"When we should be teaching young students about long-term investing and the magic of compound interest, the stock-picking contests offered by our schools are in fact teaching them about short-term speculation."

Charlie Munger has expressed similar views.

"There's no reason to have a system where every young man has $ 8 billion to play with and buy whatever he wants. It's incredibly stupid. It's absolutely crazy. If I were in charge, I'd take away everything from banks that wasn't boring. Completely shut down [credit default swaps] 100%. What's the harm in this? The world worked just fine without them. We don't need an economy that resembles a vast poker tournament." - Charlie Munger at the 2009 Wesco Shareholder Meeting

For me, large price distortions in the stock market has got to hurt the real economy. Some may ask when Coca-Cola* was selling at 50+ times earnings in the late 90's what's the harm? Well, significant mispricings can lead to distortions in the capital allocation process. Mispriced assets leading to misallocated capital. This might prevent, or at least delay, capital from getting somewhere else where it'd be more useful for economic development. Those misallocated dollars in Coca-Cola (or Cisco, GE, and just about any internet stock at the time), for example, might instead be used to help some entrepreneur get a good idea, in a timely way, off the ground that ultimately would create wealth and jobs.

Obviously, the problem is not that the money disappears in this example. Someone's is always on the other side of the trade. It's just a very inefficient way to do the business of capital allocation and development. You end up with certain industries overcapitalized -- maybe resulting in overcapacity/excess supply -- while others with merit don't get off the ground or are delayed.

 The process becomes truly destructive is when lots of fresh capital goes into a bunch of internet startups with little merit while more useful things don't get funded sufficiently or at all.

In the late 1990s, plenty of market participants, professional or not, were buying overvalued shares of Coca-Cola, GE, Cisco. Even worse, some were buying things like Pets.com. We've also just recently experienced an enormous speculative housing bubble followed by a commodity bubble.

The markets have always been a bit manic in nature. It swings -- more than occasionally -- from excessive exuberance to excessive fear. That's not going to change. 


It's just that, in its current form, it seems designed to amplify that tendency. 

Adam


Long stocks mentioned

* Coca-Cola was most certainly overpriced -- selling at a price that far exceeded per share intrinsic value -- in the late 1990s. Today, at the very least Coca-Cola's intrinsic value has, give or take, caught up to its stock price.
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