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business newsIs the Stock Market Stacked Against Mere Mortals?
By
Justin Rohrlich
Mar 23, 2011 2:15 pm
Americans pulled $60 billion out of US stock funds in 2010. Do individual investors even stand a chance?
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While inflows seem to be picking up again, there is still a great deal of suspicion among the general public that the deck is impossibly stacked against them.
In November, former New York Governor Eliot Spitzer told the Associated Press that, “Virtually everyone on the Street believes there are significant improprieties, and I think there is an even more important point for the massive number of investors who are not Wall Street players. And that is for most of us, you can't beat these guys at their own game."
This is one reason why people like Mark Swenson, a 43-year-old plumber from New Hampshire “who refuses to buy individual stocks,” say that “A large part of trading has to do with trust, and I don't have it. When a stock moves up 10 percent, you don't know why. We can pretend that everyone has access to the same information, but they don't.”
What happens to a market when the average investor -- rightly or wrongly -- no longer wishes to participate against institutional investors like Goldman Sachs (GS), JPMorgan Chase (JPM), and Morgan Stanley (MS)? Can one person ever truly hold his or her own in the same sandbox as a Bank of America (BAC)? Or a Wells Fargo (WFC)?
We may be able to start looking for an answer via a question posed by the New Yorker’s Ben McGrath this week in an article about Barry Bonds, titled “The King of Walks.”
The lengths to which he went in pursuit of maximizing his talents are perhaps unparalleled in the history of the sport. So then: What if a professional athlete became so good at that supposedly most difficult of all things -- hitting a pitched baseball -- that no one else really wanted to play against him?
McGrath continues:
Bonds was intentionally walked with the bases loaded. He was intentionally walked with the bases empty. He was intentionally walked, in fact, one out of every five times he came up to bat in 2004 -- and that’s not counting the several dozen times he was unofficially sent on his way with junk so far off the plate that even the most impulsive of batters would never have dared swing… With his minimalist stroke and robotic discipline, he was like a video-game player who had found a loophole in the programming code to exploit. It’s fun until, all of a sudden, it’s not.
Are individual investors, in reality, competing against others who are all jacked up on a financial version of Deca-Durabolin?
Professor Hany A. Shawky, director of the Center for Institutional Investment Management at the SUNY Albany School of Business, tells Minyanville that “there is no question that some small investors feel shut out” of the markets but does not believe the perception of unfair play necessarily lives up to the reality.
“We haven’t seen any superhuman beings that can beat the market to a point at which they don’t work anymore,” Shawky says. “Steroids gave Barry Bonds a little bit of an extra edge, but he already had the hand-eye coordination needed to hit more home runs than anybody else. Based on historical facts and many empirical studies, the advantages held by institutional investors are not superior to those held by small investors.”
And the “performance-enhancing” high-frequency trading algorithms that seemingly can’t be beaten -- but, in fairness, provide necessary liquidity to financial markets?
SUNY Albany’s Shawky argues that they “lose money more often than people think.”
“High-frequency traders don’t have a track record at all,” he says.
On the other hand, J. Bradford DeLong, who knows a thing or two about financial markets as well (professor of economics at the University of California at Berkeley, chair of its political economy major, research associate of the National Bureau of Economic Research, visiting scholar at the Federal Reserve Bank of San Francisco, and deputy assistant secretary of the Treasury during the Clinton administration), contends the issue of fair play in the financial markets was a problem long before the general public had ever heard of Bernie Madoff or a “flash crash,” for that matter.
“I would say [the Bonds analogy] has made sense for an awfully long time,” DeLong tells Minyanville. “What are you doing actively trading when you’ve got Nathan Mayer Rothschild on the other side? Or, look at Dickens -- when his characters invest in canals and railroads, they inevitably get cheated, Mr. Merdle turned out to be a fraud, selling unhedged puts and so forth.”
To DeLong, the mystery is “why people trade as often as they do.”
“If it’s a good deal for you to be buying a stock at a certain price, it’s important to consider why the counterparty might be selling,” he says. “The fact that so many investors don’t think about that before they trade, and, in essence, throw a fastball straight down the middle to Barry Bonds, is the real question to me.”
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No positions in stocks mentioned.
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