BU's emeritus Professor Nigel Jump writes the next in his blog series on the Dorset economy.
Stock markets aim to raise funds for future corporate growth and development by providing an efficient market for recycling cash and rewarding diverse, strategic ownership. They help to tie those who need investment funds for projects that offer the potential of good returns with those who have funds available for investment. When things are going well, they have a role in supporting democratic funding of a range of businesses - from established major conglomerates to small, but growing, newcomers. At other extreme times, however, they can be a source of greed and indulgence or disruption and panic. It is possible for them to ‘crowd out’ good investment opportunities, especially those in places beyond the main financial centres, and ‘crowd in’ monopoly or oligopoly positions for established players.
Stock market prices reflect the total value and net worth of the companies listed on a ‘public’ exchange. In aggregate, they discount general macroeconomic and policy conditions both extant and expected. Meanwhile, individual securities are affected by the market and trading conditions of specific businesses and sectors. Over time, values tend to revert to mean in terms of returns on equity investment, with individual and indexed share prices moving in line with the underlying profitability of particular companies. As well as broad macroeconomic performance, such returns reflect business strategies and market prospects and investors’ analysis of the worth of corporate leadership, assets and capacities.
In the long run, stocks tend to move in line with corporate growth and productivity performance, themselves mostly reflecting broad macroeconomic trends. In the near term, they are subject to shocks, positive or negative, which can be economical-political or technical-spatial in origin. Investor mood and confidence matter too, sometimes leading to periods of under or over valuation. But, in the end, real and anticipated underlying value should drive the equity prices of individual companies, industrial groups, geographical markets and/or overall market indices.
The background macro-environmental factors of growth and trade, inflation and interest rates, investment and taxation usually set the tone for stock markets. The relative dynamic and absolute reality of the relevant productivity factors, (investment, innovation, skills, entrepreneurship and competitiveness), often determines the performance of particular company prices. Alternative and/or substitute asset values, including bonds, property, and commodities, are other relative demand drivers, within a framework set by the political-socio-economic outlook.
So, where are we right now?
The recent history of ‘stagflation’, with relative financial uncertainty, means weaker comparative performance for UK dependent stocks (often different from UK-owned stocks – hence, the weaker performance of the ‘more domestic’ FTSE250 compared with the ‘more international’ FTSE100). The UK’s poor productivity and investment record in the 21st century means there has been over-emphasis on short-term factors, especially with regard to sustained profitability. Excessively accommodative monetary policies have not helped, together with, at times, some odd fiscal incentives.
Recently, markets have been volatile, reflecting the uncertainty about how high interest rates will climb and how much the money supply will stall in North America and Europe i.e., about how much of an economic correction is needed to squeeze out inflation. In the context of a major European war, and its impact on key supply issues, there is also the uncertainty about whether companies will hesitate or anticipate future cyclical adjustments and rebounds.
During winter 2022/23, equities have been quite highly priced around the world, still based on the bounce back from pandemic. Many commentators, however, are concerned about current share price levels, fearing an overvaluation given the weak macro prospects, the uncertain or unfavourable policy outlook, and the insecurity of strategic and tactical company intentions. Facing a possible recession with high interest rates and inflation, there is a chance of a downward price correction, especially if corporate investment budgets are constrained by high risks and wide uncertainties. Given a potential climate of fear, there is concern that major listed companies are more inclined to give earnings back to shareholders rather than to invest in the productivity drivers of future development.
Several stock markets have been volatile recently, albeit around good levels (FTSE100 near 8000 as I write), in anticipation of central bank officials raising short term interest rates further and, thereby, softening corporate growth and profitability. Profits underwent a strong recovery in 2022 for many key companies, including banks, energy and some technology-driven providers. Investors now seem to be discounting a softer performance reflecting macroeconomic stagflation, tighter policy responses and damaging geo-politics.
Overall, a stock market correction to a new base may be part of the necessary adjustment from which cyclical factors can start to advance corporate prospects once more. Equities can turn quickly when the ‘worst’ is perceived as being ‘over’ for policy and the economy. For now, however, on a wave of risk aversion, the market feels like a ‘bear’ rather than a ‘bull’ ... and not just for the United Kingdom. With a bit of research, it is always possible to find some gems amongst the broadly mediocre: the firms with strong staff, efficient systems and infrastructure, good market penetration and innovative product and growth plans. Nonetheless, for many other equities, a period of ambiguity seems likely and, for some, there remains a need to weed out the non-competing.
Maybe we need to endorse other sources of finance for the development process in the mid-late 2020s. One suggestion is for stock markets to re-localise, attracting investment funds into regions and sub-regions and for innovative investment models. For example, some promote Community Development Finance Institutions (CDFIs) that aim to attract and distribute investment funds locally. Could place-based investment vehicles offer sustainable improvements for ‘left-behind’ communities?
This could be supported by more local stock exchanges. If banks, government and private investors can be shown where the regional and industrial potential for future development exists, perhaps a local equity market - (a Wessex Stock Exchange?) - can open up direct finance for local opportunities: ones that can lead a future upturn in growth, productivity and investment returns. Could this take us beyond, (potentially more efficiently and effectively), the rewards of traditional, international stock markets? Could this allow a different focus on green, AI and other ‘upcoming’ sectors based on de-globalisation and, resilience, and offering high-skilled, high-wage jobs, profitable value creation, and, ultimately, better living standards?