Today’s U.S stock market is very different from the stock market of forty or even twenty years ago.
To start, the universe of publicly traded stocks has become much smaller. There are fewer listed stocks than in the past. The phenomenon is discussed in a report issued earlier this year by Credit Suisse, The Incredible Shrinking Universe of Stocks.
Back in 1976, the stock market was comprised of 4,796 listed companies, roughly 30 percent more than there are now. From 1976 to 1996 the market expanded by over 50 percent to 7,322 companies. Since then, however, the number of listed stocks has been cut in half. By the end of 2016, the number of listed stocks had fallen to 3,671.
Stocks are delisted for one of several reasons: mergers, acquisitions, bankruptcy, or voluntary delisting. New stocks become listed most often as a result of IPOs and sometimes because of spin-offs. The Credit Suisse report cites research indicating that the universe of stocks shrunk both because of an increase in the rate of delisting and a drop in the number of new listings.
Most of the stocks that disappeared from the market were smaller companies, known as small-cap stocks, and the even smaller micro-cap companies. By 2016, there were about 3,400 fewer of these small companies listed in the U.S. stock market than twenty years earlier.
The result, according to the Credit Suisse report, has been that the remaining companies are on average larger, more established and more profitable than in the past. That doesn’t sound like a bad thing but, as we will discuss later, it does have implications for investors. Also, fewer companies mean that some industries are more concentrated with fewer competitors.
A second significant change has been in the composition of ownership. The individual investor who directly owns stock no longer dominates the stock market. Institutional investors do. In 1950, over 90 percent of the stock market was owned directly by individual investors. Today, that number is believed to be less than 30 percent. Most of the market is owned or managed by institutional investors, which includes pooled investments such as mutual funds, exchange-traded funds and pension funds. Individual investors still own the majority of stocks but mostly through indirect ownership in the form of mutual funds and exchange-traded funds.
The shift in stock ownership and management has contributed to a third significant change, a shift in trading patterns. Decades ago, individual investors were responsible for most of the trades placed. In recent years, however, about 90 percent of stock trades are made by institutional investors.
Quantitative trading driven by computer run algorithms is estimated to account for at least 60 percent of the stock market trading volume. A single exchange-traded fund, the SPDR S&P 500 ETF, which tracks the S&P 500 Index, is reported to have accounted for about 9 percent of the trading volume on the New York Stock Exchange over the past five years.
In 1990, the average daily trading volume on the New York Stock Exchange was 162 million shares. In recent years, the average daily volume of stock trades is frequently measured in the billions. In short, there is more active trading going on and much more turnover in the stock market than in the past.
In today’s stock market, there are fewer stocks to choose from, the remaining companies tend to be larger, most stocks are owned or managed by financial institutions rather than individuals, and trading is dominated by large, sophisticated entities running computer-driven algorithms.
What might all this mean for investors?
- The Credit Suisse report speculates that fewer but larger companies make the market more efficient than in the past. “Efficiency,” in finance-speak, refers to the availability of information. An efficient market is one in which most or all of the information needed to effectively price a security is publicly known making it difficult for any investor to have a competitive advantage over other investors.
- A smaller universe of stocks from which to choose makes it more difficult for managers to find market-beating opportunities overlooked by others. The annual scoring by S&P Dow Jones comparing active v. passive investment results bears this out.
- Individual investors are at a serious disadvantage relative to institutional investors.
Investment strategies that worked in the past are not guaranteed to work in the future, especially in a market that is very different than yesterday’s. We are constantly reminded that past performance is not indicative of future results because it’s true.
This article appeared in the October 19th, 2017 issue of The Daily Record. Download a PDF copy.