We witnessed quite a bit of geo-political activity in February most of which arose out of the Middle East. The turmoil in Tunisia, Egypt, Yemen and, most recently, Libya has caused a spike in oil prices and contributed to growing global commodity price inflation. The consequence of this has been highly volatile markets with most emerging markets suffering most and energy related equities performing best ⁽¹⁾. We remain confident emerging markets will withstand the turmoil thanks to strong balance sheets and healthy fiscal discipline, however, we will be vigilant in monitoring volatility and will take appropriate steps, if necessary, to manage portfolio volatility.

I recently had an article emailed to me which I think is worthy of further discussion. Felix Salmon, a blogger for Reuters, wrote an editorial in the New York Times, dated 2/13/11, entitled "Wall Street's Dead End". I believe this is a common story, recounted every few years, whenever a writer believes "Main Street" needs motivation in the ongoing struggle against "Wall Street". Many of the writer's points are arguable depending upon one's bias.

The writer claims "the stock market is becoming increasingly irrelevant" and believes this is a "trend that threatens the core principles of American capitalism". He supports these statements by suggesting "these days a healthy stock market doesn't mean a healthy economy", however, according to a study by Vanguard ⁽¹⁾ finds "since 1900, the correlation of long-run economic growth..and long run stock returns across 16 markets has been effectively zero." In fact, the slope of the regression line is actually zero. To most investors, financial markets are discounting forward expectations not current or historical results. Mr. Salmon caveats his comments by stating "the stock market is still huge, of course, the companies listed on American stock exchanges are valued at more than $17 trillion." This is true, of course, and, while down from the peak of $19.9 trillion at the end of 2007, is up from $3 trillion in 1990, an annualized increase of roughly 9%⁽²⁾.

He then says "the glory days of publicly traded companies" are over. He notes that the number of listed companies on major exchanges has declined from a peak in 1997 of more than 7,000 to less than 4,000 at the end of 2010. In fact, the peak was at 8,823 companies in 1997 and has declined to 5,095 ⁽³⁾. The peak coincides with the peak of the Internet bubble. Most of the "companies" were nothing more than an idea and many were brought public by either founders or venture capitalists to create liquidity for them and their investors. Most also provided zero economic benefit before, during and after their public lives. There were 6,765 public companies in the US in 1990, of which 4,132 were listed on NASDAQ. At the end of 2010, there were 2,852 public companies. As for NYSE, in 1990, there were 2,633 (including the American Stock Exchange which was acquired by NYSE) and at the end of 2010, there were 2,327⁽⁴⁾. It is evident that the preponderance of the decline in public listings is on NASDAQ rather than NYSE. NASDAQ has historically been home to more volatile and weaker companies so the decline can arguably be considered a positive as fewer "speculative" issues are coming to market. Again, arguably, this is creating a healthier environment for "Main Street" investors. This is contra to Mr. Salmon's thesis that the stock market "is becoming little more than a place for speculators and algorithms".

Finally, Mr. Salmon states "With America Inc, owned by its citizens, the success of American business translated into large gains in the stock portfolios of anybody who put his savings in the market over most of the post-war period". According to a study by Friedman (1996), aggregate institutional ownership increased from less than 10% in 1950 to over 50% by 1994. This work is cited in another paper by Gompers and Metrick⁽⁵⁾, which suggests that this shift can explain some of the disappearance of the historical small-cap premium. Institutional investors favor large, liquid companies with low returns in prior years (value).

I appreciate Mr. Salmon's desire to return to a simpler time when investing lead to "large gains" for "Main Street" investors. Unfortunately, the wishful thinking is misplaced.  I do not believe that stock markets are in perpetual decline and have become a "noisy sideshow". I do believe stocks markets are more global than ever and I do believe "Main Street" investors are fully engaged in this shift and benefiting from global returns and will continue to do so as both the global and domestic equity markets continue to evolve.

 Sincerely,

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(1)     http://topforeignstocks.com/2010/11/07/emerging-markets-correlation-between-economic-growth-and-stock-market-returns/ 

(2)     World Federation of Exchanges - http://www.world-exchanges.org/statistics/time-series(3)     World Federation of Exchanges - http://www.world-exchanges.org/statistics/time-series(4)     World Federation of Exchanges - http://www.world-exchanges.org/statistics/time-series(5)     Institutional Investors and Equity Prices - http://www.cenet.org.cn/userfiles/2010-5-17/20100517202607262.pdf