The Stock Market
It is hard to get through a newscast without there being frequent mention of how the stock market has performed for the day. Such frequent reporting would indicate that the stock market plays an important role in the American economy. The information below should help the student to better understand the importance of the stock market in the American economy.
What Are Stocks?
Corporations can raise funds through the sale of stock to the general public. Stock is sold so that a corporation can raise money primarily as a form of capital investment. But there is also the benefit of having the risk of a new venture spread out amongst many people. A stock is a share in the ownership of a corporation. Stockholders are owners of the company and are entitled to a voice in the selection of the Board of Directors, as well as a share in the profits. For example, if a company sells 1,000,000 shares of stock, then each share represents 1/1,000,000 ownership of the business.
According to a recent Gallup survey, the percentage of Americans saying they hold individual stocks, stock mutual funds, or stocks in their 401(k) or IRA fell to 54% in April 2011- the lowest level since Gallup began monitoring stock ownership annually in 1999. Stock ownership peaked in 2002 at 67% and has since been on a steady decline. However, the disappearance of the individual stockholder as the backbone of the U.S. stock market has been one of the least recognized but most profound trends of the last half-century. In 2007, the wealthiest 1% of households owned an average of $4.2 million in stocks (in 2009 dollars). The next 9% owned an average of $526,100. By comparison, the average stock holdings of the middle 20% of households was just $10,200, and the average for the bottom 40% was $1,700. These data confirm that stock ownership is not very pervasive in the middle and lower wealth classes. The unprecedented growth, for the most part, was enjoyed by wealthy investors: 81.1% of the rise in the overall value of stocks holdings over the period went to the wealthiest 10% of households, compared with 1.5% to the middle 20% and 0.5% to the bottom 40%.
Direct ownership of stocks by American households has declined from 91% in 1950 to just 14% in 2013. In 1950, financial institutions owned 9% of stock. In 2005 they owned 68% of all stock. Institutional investing is now largely the business of giants. America’s 100 largest money managers alone now hold 58% of all stocks. Of course individual investors remain major participants in the stock market, but now do so largely through mutual funds and public and private pension plans. But such participation lacks the traditional attributes of ownership such as selection of individual stocks and engagement in the process of corporate governance.1
Protecting the Investing Public There are opportunities for corruption in the stock market. Insider trading, disinformation, and false rumors, create the need to protect investors. The Securities and Exchange Commission is an agency which tries to protect investors from wrong doing the sale of securities. Corporations need to provide accurate information to both current and potential stockholders. They are required to provide a prospectus whenever a corporation sells new securities. A prospectus is a financial statement of the corporation, covering such things as assets, liabilities, and sales. The SEC has been under a great deal of criticism because of its cozy relationship with the businesses they are supposed to regulate. A report from the Project on Government Oversight found that former employees of the SEC routinely help corporations try to influence SEC rulemaking, counter the agency’s investigations of suspected wrongdoing, soften the blow of SEC enforcement actions, block shareholder proposals, and win exemptions from federal law. 2
The Role of the Stock Exchange
Once the stocks of a corporation have been sold to the public, all future sales are handled through the stock exchanges. The New York Stock Exchange and the NASDAQ (National Association of Securities Dealers Automated Quotations) are the two most widely used stock exchanges in the United States. The stock exchange is run like an auction. Buyers and sellers compete (bid ) for the price of the stock. The stock market is where stocks are bought and sold. For example, Microsoft’s trading symbol is MSFT. The major stock exchanges include the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and the Nasdaq Stock Market. Each imposes specific requirements that companies must meet before their stock can be listed, or traded, on the market. Companies that meet the requirements of multiple exchanges may choose where they are traded. Brokerage houses such as Merrill Lynch and Dean Witter, are companies that are permitted to actually buy and sell stocks in the above listed exchanges. The Standard and Poors 500 (S&P 500) is an index made up of five hundred different stocks. Each is selected for liquidity, size, and industry. The index is weighted for market capitalization. The S&P 500 is the benchmark of the overall market, and frequently used as the standard of comparison in terms of investment performance. The Dow Jones Industrial Average (DJIA) is an index of thirty, blue chip stocks that are traded in the United States. It is believed that by looking at the companies on the list, a person can get a general picture of how the market as a whole is performing.
|Exchange||Requirements include||Typical Daily Volume||Number of listed companies|
|NYSE||1.1 million publicly held shares minimum; $40 million minimum market capitalization||1.4 billion shares||2,800|
|NASDAQ||Various quantitative and qualitative requirements||1.9 billion shares||3,200|
|AMEX||500,000 publicly held shares minimum, $3 million minimum market capitalization||51 million shares||765|
As of April 22, 2013
Why Some People Buy and Sell Stocks
Some people are interested in making money in a short amount of time in the stock market. These people are known as speculators. Those who look to make money over a long period of time are known as investors. Corporations give investors an extra benefit for their confidence in the corporation. This benefit is called a dividend. A dividend is a periodic payout of profits given to investors. The value of a stock is determined by the supply and demand for the stock of a company. The demand for a stock, as well as the price of the stock, reflect people’s perceptions of a corporation’s future profitability. When people are optimistic about a business’s future, the demand and price of the stock goes up. If people are pessimistic, the opposite is true.
The use of high frequency trading has grown substantially over the past 10 years: estimates hold that it accounts for roughly 55% of trading volume in U.S. equity markets and about 40% in European equity markets. Likewise, HFT has grown in futures markets—to roughly 80% of foreign exchange futures volume and two-thirds of both interest rate futures and Treasury 10-year futures volumes.
Types of Markets
A Bull market refers to speculators who anticipate making money from the increase in the price of a stock. This happens when a large number of stocks traded on the exchanges go up over an extended period of time. Bull markets can be sustained over a long time span. However, many investors achieve gains in short spurts. Bulls markets are desirable for many reasons. A bull market means the economy is generally doing well, gross domestic product is increasing, the job market is heating up, and people are spending money. A Bear market refers to speculators who anticipate making money from the decrease in the price of a stock. This happens when a large number of shares in the exchanges decline over an extended period of time. For people who invest in the stock market over the long term, they will probably encounter at least one bear market. There is no one agreed upon definition of a bear market. A bear market is generally defined as a decline of 20% or more in broad market indexes over at least a two month period. The worst bear market occurred from September 1929 through July 1932 when stock prices fell 86%.
The Stock Market’s Impact on the Economy
Many people follow the stock market to see how their individual stocks are performing. But the stock market also can be used as an indicator to how the economy is performing. If the stock market is believed to be a good investment, then many people will put their money into it as an investment. This means American corporations have a sizable pool of money to use for capital investment. If the opposite is true, then investors will keep their money out of the market. This means American businesses would have less money for investment, which means they might lose their competitive advantage to other countries. This in turn would mean lay offs down the road for American workers. The stock market is also related to interest rates. If interest rates rise, investors may pull their money out of the stock market and invest it elsewhere. If interest rates are low, investors may pour money into the stock market in hopes of getting a higher return. The general connection between the stock market and interest rates, then is that when interest rates are high, stock prices decline. When interest rates are low, stock prices increase.
When you watch the news and here reports that the stock market has gone down in value, is that always bad? Not according to Dean Baker, Co-director of the Center for Economic and Policy Research. In a speech on February 28, 2007, he said:
“A lower stock market is good for a lot of people. If corn prices fell 30 percent, that would be bad for you if you’re a corn farmer, but good for you if you weren’t and ate a lot of corn. Stock ownership is highly concentrated; 75 percent of the population holds little or no stock (including retirement accounts), so if stocks go down and you don’t own any, you’re better off.
“When stocks plunge in value, it’s similar to a situation where there are trillions of dollars in counterfeit currency, held by a small group of people, and the police seize and burn it. This is good news for the rest of us because the trillions of dollars of counterfeit money will not be bidding up the prices of things like houses and cars. Any honest economist would have to concede this point — it’s elementary economics, but many economists tend to cheer the stock market, in effect favoring the wealthy at everyone else’s expense.”
“Greenspan, as head of the Federal Reserve in 1987 intervened to bail out the stock market. The federal government takes as a goal higher stock prices — they don’t have higher wages as a policy. In retrospect, this intervention set the stage for the stock bubble of the 1990s. The U.S. government in effect subsidizes stock owners, who tend to be wealthier.”