My broker called with a stock recommendation, yesterday. Beaten down by Covid-19 uncertainty, this long-established company had a good balance sheet, modest debt, and paid a decent dividend. I decided to take the recommendation. As a rule these days, I’m nibbling cautiously because the pandemic has revealed how value has become unmoored from reality.
What I try to remember about the stock market is that it attempts to foresee the future not evaluate the present. “Over 90 percent of the value of stocks is dependent on earnings more than a year in the future,” writes one expert. (“How the stock market is failing America,” by Michael Steinberger, excerpted from New York Times Magazine, by The Week, June 12, 202, pg. 37.) A lot of unforeseeable events can happen in a year. Some scientists speculate a volcanic eruption in Alaska led to the eventual fall of the Roman Empire.
One trend I hadn’t noticed is that large companies are relying less on the stock market to grow capital. Instead, they are turning to private equity firms where they avoid scrutiny and government regulation. Sometimes, they use their money to buy back stocks. Doing so does nothing to increase the company’s productivity, but it may increase the stock’s price because fewer shares are available. At such times, large holders are tempted to sell and pocket their profits, leaving smaller investors to take the long term risk. Share buybacks are one reason why a rise in the Dow Jones isn’t a barometer of a healthy economy. Small businesses do the heavy lifting and, because of the Covid-19 shutdowns, they have been hard hit. (Ibid, Pg. 17.)
Another reason exists to explain why the stock market can experience sharp rises in a down economy. Says billionaire Leon Cooperman, it’s due to the growth of zero-commission discount brokerages, like Charles Schwab and Robinhood. People at home and out of work seem willing to gamble that the market may help them recoup losses. So far they’ve been right. Small day traders are beating the pros. Cooperman believes the get-rich mentality has turned investing into a wild west.
Meanwhile, the present keeps paving the way toward the future. If I had to place a bet, it would be that the rich will get richer.