How Much Can A Market Bear?


Remember the "shareholder society"? It was one of cherished dreams of John Howard, who championed the idea of ordinary citizens investing in the stock market.

In a 1999 speech to the Queensland Chamber of Commerce and Industry the then prime minister celebrated the privatisations that his government had undertaken, which had helped, he said, "build a nation of shareholders with almost 4 million Australians directly investing in the share market".

"In less than four years, more than one in 10 adult Australians have become shareholders for the first time," he declaimed. "Nearly 2 million Australians have purchased shares in Telstra. All of them have a direct stake in the growth industries of the future."

And so they did. During the Howard years, Australians took to share market investment and trading with gusto, egged on a by a privatised ASX that held "investor seminars" up and down the country. Financial innovation also enabled small investors to access sophisticated investment tools like Contracts for Difference  and margin loan facilities.

Ordinary investors helped supercharge the long Australian share boom that ended in 2007. As financial journalist Michael West wrote in January this year, "the rally in share prices since early 2003 has gone hand-in-glove with the spectacular growth in Contracts for Difference (CFDs). Like any leveraged product, a CFD delivers turbo-charged returns — if you are on the right side of the trade."

But how do we figure out where the right side of the trade lies? There is much to be said for improving the financial literacy of ordinary citizens. As Warren Buffet noted in a recent New York Times article, leaving your money in a savings account is one of the worst things you can do with it long term.

Of course, the length of the term is what matters, as John Maynard Keynes famously quipped. If you’d invested in the US stock market in the 1970s, you wouldn’t have seen any capital appreciation until after 1982. But over the course of 20 or 30 years — the kind of long term investment timetable that helps to insulate you from short term volatility — shares seriously outperform cash.

If you’d left your money in cash this year you’d still have it all — unlike the haemorrhagic losses of anyone who had investments in Australian equity markets, let alone the poor souls with margin loans or significant holdings in dead companies like ABC Learning. Of course, each dollar you own would be worth around 4 per cent less, due to inflation, but you probably made a few per cent in interest in a savings account, leaving you just about even. In the context of a stock market currently trading at around half its peak, even-stevens is pretty good.

In the bigger picture, however, the long-term performance of equities "smoothes out" the tremendous wealth destruction of share market collapses. The problem is, many Australians now investing do not remember the last long term bear market in global equities that ended in 1982. Despite the dramatic events of October 1987 and the subsequent recession of the early 1990s, stocks soon resumed their bull run. Now we’re in another long term bear market, and ordinary citizens are hurting. This one will continue for some time, driven by economic fundamentals like a global recession in the rich world economies.

The problem is that with so many Australians now holding equities portfolios, the effect on consumer sentiment of massive losses in those portfolios (even if they are only "on paper") are significant. Whether or not you believe in the "negative wealth effect", the effect of having to make massive margin loan calls is real for many investors. Money tipped into CommSec or a similar margin loan facility is money that can’t then be spent at the cafe, the hotel or the shopping mall.

How big has the wealth destruction of recent stock market falls been? Really big. A lot of the biggest recent falls on the ASX have been in the blue chip mining companies many small investors mistakenly thought were "safe". The plunge in world commodity prices over the past month has hammered BHP and Rio shares, while the losses at small miners have been even worse.

The "shareholder society" encapsulates the problems of neo-liberal economic thinking. As ever more people and aspects of society are exposed to the forces of unfettered free markets, so too are ordinary citizens exposed to more risk. Unfortunately, many of us don’t understand these risks. In good times, everyone makes a lot of money. In bad times, ordinary investors are wiped out and the panic can spread across the economy.

Of course, there is another way in which western nations are becoming "shareholder societies". Taxpayers are becoming owners — or guarantors — of large financial institutions like Citibank. Over the weekend, the massive global bank was bailed out by the US Government with taxpayers taking on large parts of the company’s toxic debts. Citibank, of course, was "too big to fail".

This, then, is the "shareholder society", 2008 style. It’s where a whole society becomes a big shareholder in major corporations — and their losses.

Ben Eltham is New Matilda's National Affairs Correspondent.