If you read typical finance articles out in popular media you commonly see facts and figures about how US stocks outperform other investment classes over “the long term”. As I do my own research I tend to see threads leading back to the premise that US stocks are entering a new environment going forward and past results are going to be less and less relevant in predicting future performance. One of the reasons for this is the fact that the United States has ceased to be a dominant player in launching new public companies, and in fact is now mostly an also-ran when compared to Chinese markets or even Brazil as of late.
The Agricultural Bank of China is about to come out as an Initial Public Offering next week that will be one of the largest IPOs of all time. Per this article:
Hong Kong and China have dominated the global IPO market. That dominance will only increase when Agricultural Bank of China starts publicly trading next week. In 2009, Hong Kong was the world’s largest IPO market, with companies raising a combined $32 billion in capital, according to Dealogic, a data-tracking firm. This year, China is on track to assume the mantle, with $31.7 billion raised by early July.
The Wall Street Journal had a recent article titled “How to Fix the IPO Market” by Jason Zweig. I didn’t agree with their analysis or recommendations but the article did have a lot of useful facts and figures that illuminate the changes in the public markets in the United States, such as the following:
Ten years ago, around 9,100 companies filed annual proxy statements with the Securities and Exchange Commission. Last year, roughly 6,450 did; so far in 2010, only about 4,100 have, estimates Wharton Research Data Services. In two-thirds of the years from 1960 through 1996, the number of initial public offerings exceeded the number of stocks that dropped out. Since then, however, there have been more deaths than births among stocks every year: 7,725 stocks have disappeared over that period, while just 4,299 new ones have arisen to replace them, according to Wharton.
What is happening is that existing companies are swallowing up smaller companies and other ones went bust during the market tumult. New companies, however, haven’t joined them. Recently there was a bit of a hoopla about an IPO for Tesla Motors, which raised $266M. However, prospects for the car maker are cloudy and the stock has declined below its offering price since then. If Tesla, a loss making niche enterprise, is the future of our growth companies, we are in trouble.
The reason that this matters is that the entire “stocks outperform over the long run” is based on data from a few markets that haven’t suffered major disruptions (war, occupation) which pretty much brings you down to US and UK market data, mostly US data. And this data was based on a continuous growth in companies launched through IPOs with a growing market for companies; today the market for US based companies is small and much of the new and larger IPOs are happening overseas.
There is nothing wrong with overseas markets growing; it is just that the US markets seemed to have stopped, and investor money (both US and foreign based) is going where the IPOs are. While we do not see the “full” effect of this trend, because many large multinationals are still US based and doing well, we will see it in the future as the newer companies don’t fill in the gaps and come through the ranks at some point in the future.
This doesn’t mean that I am saying that US markets will go up or go down as a result of this; I am just saying that the long term data was based on a premise that new companies would grow to replace the old (“creative destruction”) but in fact the new companies aren’t coming up in the footsteps. Perhaps stocks are best in the “long run” in aggregate across all markets but it may not be US based stocks if we just have aging companies and the young, growth companies are nurtured elsewhere.
Cross Posted at LITGM and Trust Funds for Kids
Part of this is that venture capital funds are holding onto the new companies in private status longer before doing an exit…and when they finally do the exit, it may take the form of sale to a large corporation rather than an IPO of the venture company. In some cases this will be fine; in other cases, premature absorption by a large firm will result in missed growth opportunities.
Note also that venture capital is largely funded by people who are reasonably well-off, and that increased tax rates on such people must almost inevitably reduce the amount of $$$ invested in VC funds.
The real problem is that the institutional basis of the small IPO market is gone. The regional broker-dealers, the regional stock exchanges (Midwest, Cincinnati, Phiadelphia, San Francisco, etc.) have disappeared and not been replaced. It is not possible to do small deals off the major exchanges anymore. The 4 national accounting firms do not want to deal with small IPOs either.
My father was a securities lawyer, as was I, he did IPOs for a bunch of little local companies. Most of them went under years ago. The only one that made the big time was the Limited (LTD), but that was enough to pay for his grandchildren’s educations, his widow’s old age, and his son’s retirements.
Can we revive small IPOs? No. The institutions are gone and they will not reappear. Can we find a way to replace them. We must.
I agree with both of your comments.
I also believe that there are a lot of companies that are “stuck” in VC land and they aren’t going public because the market stinks and they don’t want to tank upon going IPO.
Meanwhile the investment capital that would have gone to them is chasing better investment climates around the world, or not being raised at all.
Whatever the reason, since we are choking off the future growth companies, it is likely even more unwise to extrapolate the past onto the future than it was previously.
Another factor: the increased hostility toward business in the U.S., combined with greatly increased opportunities in both India and China, means that many talented individuals who previously would have come to the U.S. and started businesses here will instead stay at home and do their entrepreneuring there…and some who are *already* in the U.S. will decide to return to their home countries.
I am not a financier, nor do I play one on TV. Did not stay in a Holiday Inn Express last night either. But it seems to me to go beyond David Foster’s cogent comments.
We have a country where “regime risk” is now a very important factor. Looking at the beating that corporate law took in the functional nationalization of GM and Chrysler [and the blatant robbery of both secured creditors and stockholder (the owners)] in order to pay off political allies; if you are any sort of investor [let alone a VC] you have to pause. I am definitely not a fan of BP Oil. Yet, one has to wonder on what legal authority the president successfully extorted a $20 Billion ‘escrow fund’ to be managed by his personal appointee outside of normal Federal processes? What does that imply about the future safety of investment in our country?
At the same time the regime’s party which controls both Houses of the legislature has literally refused to create a formal budget for the next year, and did not even go on record by vote to do so. They “deemed” the budget law to be obeyed and will fill in the blanks later.
One of the major government expenditures is Social Security. Every year, no later than May; the Social Security Actuary releases an annual report according to law. That report has to include a detailed actuarial projection for the next 75 years, based on the status of the Social Security Trust Fund. We are in July, and there is no sign of the report. Investor’s Business Daily has raised the possibility that a combination of government raids and a collapse in employment far worse than government manipulated statistics would indicate has brought Social Security visibly closer to collapse; and that is why the report has not been issued.
A country run by a government that does not see itself as being bound by law, that demonizes business, and that is going broke even with massive tax increases already scheduled … may not be the safest and most desirable place to invest or take financial risks.
Subotai Bahadur
The problem is SarBox and the mentality that the innocent must be punished for the sins of the guilty. The government elite don’t like or trust business activity. We have a new aristocracy, just like England’s, that thinks it is above crass materialism and debasing competition. They are killing the goose that has laid the golden egg.
MrsD…The government elite don’t like or trust business activity. We have a new aristocracy, just like England’s, that thinks it is above crass” materialism and debasing competition”
This aristocracy dislikes business activity especially when it is more *tangible*….in this, it also resembles the anti-business aristocratic sentiment in England, where going into banking was not especially admirable but was far higher status than going into manufacturing or retail trade. Today’s American aristocrats and would-be aristocrats are much more willing to associate with a business person if he is in finance or software than in metal-bending or transportation or retail.
Should be noted in fairness though that some British aristocrats did make huge contributions to industrial development, viz the Duke of Bridgewater, who kicked off the canal era with his visionary developments.