Surprise: common stocks are risky. But the stock market is necessary for the survival of a free market system. Without a stock market, financing economic growth is problematic. Private companies have three mechanisms for funding growth — reinvest profit, borrow from lenders or sell stock to a limited group of investors.
In addition, a private company can engage in a strategic or financial transaction with another enterprise. Since the stock of private companies do not have a readily available secondary market, valuation and access to capital are limited.
There are numerous advantages to being a private company. Being private eliminates outside, possibly annoying, shareholders, and since private company stock price is not quoted in a secondary market, price is not determined by the public market. In addition being a public company is an extremely costly endeavor largely due to the regulatory and reporting requirements. Many professional and high net worth investors invest in private companies for some of the aforementioned reasons.
Access to Capital
However, a public company has access to capital via the secondary market for both equity and debt and has a readily available "super currency" in the form of stock, which can be deployed to acquire other companies. This is very advantageous.
The stock market serves two principal functions. It enables companies to raise capital and it provides an investment vehicle for the public. The public can buy specific stocks or they can invest in Registered Investment Companies commonly referred to as Mutual Funds. They can purchase directly or through a retirement vehicle such as an IRA or 401 (K).
At the moment, the stock market looks "ugly". But that is when great returns are achieved. Markets are strange mechanisms. They represent the opinion of the masses and they are driven by fear and greed. Bull markets are driven by excessive optimism and bear markets are driven by excessive despair. Markets are a reflection of the manic/depressive behavior of an unruly mob — individual and professional investors. As a result, the consensus opinion will be wrong. If everyone is pessimistic it is time to buy.
Market behavior is, if nothing else, fascinating. When it comes to investing — "that which is worth knowing is not known and that which is known is not worth knowing".
Sellers Get Exhausted
Markets go down because there is more selling than buying and the decline stops when the sellers are exhausted. "Markets will do that which is necessary to hurt the greatest number of investors." Research demonstrates that a consensus buy opinion is a sell signal. The recent market decline was fast and furious because the magnitude of the mortgage crisis was not anticipated by anyone — not by anyone. Markets decline rapidly because there is new news which is bad news.
In 2008 everyone messed up. The prime culprits — the Senate Banking Committee and FNMA for encouraging sub-prime mortgages (owning a home is not a right), Wall Street for employing more leverage than a catapult, and the Federal regulators for putting the brakes on state disclosure.
This appears to be a buying opportunity. We could also devote volumes to historic analysis and the actions that caused the great depression — principally a lack of liquidity by the banking system (poor government policy) coupled with excessive and retaliatory tariffs (poor government policy) — not the stock market crash.
Today's Stock Market
If we assume that the modern stock market started in 1970, from 1970 through 2007 the average rate of return for the U.S. Stock Market as measured by the Standard & Poor's 500 stock index was approximately 12.30 percent with a compound annual return of 11.20 percent. There were 8 down years (negative return) and 30 up years (positive return) and the average down year was 12.40 percent. The market was down 14.66 percent in 1973 and 26.47 percent in 1974. The following two years the stock market was up 37.20 percent and 23.84 percent respectively.
We are now in a recession. The U.S. will recover from the recession. Assuming long-term market performance demonstrates regression to the mean (a simplistic view that stock market performance tends to achieve average historic returns in the long term) the bull may be staring us in the eye.
This month,U.S. Tech is launching TECH XCHANGE. The TECH XCHANGE is a private market where private companies seeking capital, a merger, an acquisition or a joint venture partner can list their financial and or strategic preferences. Public companies can also participate.
Banks have pulled in their reins; they are even cautious about lending to each other. TECH XCHANGE is a new alternative for U.S. Tech subscribers. Check the advertisement for more details.