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Stock Markets Are Not Democratic

The stock market is not democratic. Changes in the stock market, far from being an honest representation of the state of the nation’s economy, are nothing more than a barometer for the wealthy, educated elite whose fortunes are tied to Wall Street’s performance, while the great majority of the population become spectators in increasing numbers with every advance or decline. Psychology, technology, education and social status all have become barriers preventing the equitable distribution of the gifts of regulated equities, and worse, perpetuate the imbalance by their very nature.

In the stock market, the rich get richer while the rest…just think they do.

There is an unspoken myth that participation in the stock market is wide and deep in America, and that its fortunes are egalitarian – truly a democracy open to all, and with an even shot at bonanza. In a sense, Wall Street has come to define America, and the equality of opportunity it represents. No matter how humble of station, the American dream is available through prudent investment in the stock market over the long term.

The mainstream media in the United States supports this supposition, the rise of business and investment shows, finance segments in news broadcasts, and daily headlines covering every joyous or threatening tilt in the great pinball machine. Finance news has become a growth industry, predicated as it is on the increasing desire of wider groups of viewers for immediate and insightful news and analysis. On the web, sex is still king, with finance porn coming up behind. A noun, a verb, and a stock symbol will get your blog readers almost as fast as a scantily clad avatar.

Only a third of Americans participate in the stock market through the ownership of stocks in one way or another. While that’s a lot of people, it certainly is not the strong majority that a democracy assumes. Still, changes in stock market performance do affect thirty-five percent of the population directly. However the math suggests that the best such a wide group can do in a pseudo zero sum game is to track the changes, their returns never being anything better than average.

Real increases in wealth occur in smaller, segmented sections of the stock buying population as a whole. Owning stocks alone is no guarantee of success.

For most of the stock owning public, stock ownership arrives through the back door, in market products that pool resources like mutual funds, or in market incentives like retirement tax breaks that accompany the buying of stocks in the way 401(k) plans do. People invest for the tax break, and consider the risk small or non-existent that their equity investments in stocks will melt away. They are not stock market investors as much as they are tax break investors.

In terms of risk ownership – where higher risks mean greater potential rewards – the vast amount of stock holding Americans have insulated themselves from the great rewards of stock ownership, by falsely believing their low risk, widely spread holdings will return more than low, widely spread rewards. For people who own mutual funds, automated 401(k) plans, or received stock in the company they work for, the nature and motivation of their investment condemns them to the law of averages, existing always on the fat part of the curve. They will never beat the market, as they are the market.

And while most consider the rapid, inexorable advance of the value of the Dow an important way to have their investments participate in the great game of easy wealth creation, that too is an illusion. Despite its impressive scorecard, the stock market has only averaged a real rate of return of about 4% over the long term, once adjusted for inflation. Hardly the get rich quick – or slow – scheme many believe.

Direct stock market participation is the only way to get out from under the curve, and have any realistic shot at beating inflation and adding real, sports car buying, holiday taking, coke snorting “wealth”.

Pulling together the money, reading a bit about what you are doing, tracking down a broker, and selecting from thousands of stocks to individually purchase in minimum board lots is not something Americans do in any great, relative number. According to the Federal Reserve Board “Survey of Consumer Finances”, only about 18% of stock market participation is done in this fashion. Less than one in five Americans has taken the opportunity to work the American dream directly, and pit their guts and faith against the odds.

Certainly, the advances in online technology over the last decade have made stock market participation wider, what with the profusion of discount brokers and do it yourself, on line stock trading. Wall Street on line gaming. Yet, direct participation in the market has only progressed not much beyond the 18% of 2007, from the 13% of 1991. It has never been easier to buy stocks, and with two major booms, so few people availed themselves the chance to ride the big one. Clearly, the stock market does not represent America, where 80% of the population is not participating directly in the fortunes of the corporate assets of the country, and are not a participating part of a fundamental of free market capitalism.

Contemporary culture is slathered in headlines of Wall Street, the DOW, and NASAQ, giving the impression of a country deeply wired to the fortunes of the market across all demographic spectrums. Stock market participation analysis however, clearly identifies serious barriers to entry that make Wall Street a decidedly closed, club.

A closed club of rich, educated men in high status occupations.

Wealth (like male pattern baldness), is inherited. If you are clever enough to be born to rich, beautiful parents, odds are you are clever enough to have your own kids repeat the trick. Progeny of wealthy households inherit much more than trust accounts. The basic knowledge and principles of the responsibility for all that family capital comes with the suitcase. Other folks, who lack both the capital and the joie de vive, make their first market acquisition from a decidedly disadvantaged place. In a very undemocratic fashion, a major barrier to entry appears to be to whom you were born.

The Federal Reserve Board Survey of Consumer Finances also reveals it’s better to be born a male. Men dominate the world of finance, and women have a long way to go, as you are more than twice as likely to be a man if you invest directly in the stock market.

Education also forms a barrier, as there is a direct correlation between rates of stock market participation and levels of schooling. Not surprisingly, the world of finance being a complex and disciplined world, better-educated Americans are over represented in the markets. Thirty five per cent of College graduate households owned stocks, more than all other classes combined. Easy access to transparent information is a necessary part of an informed market decision, and college grads it appears, know how to find it.

Another trait shared amongst the wealthy, smart and male is high status occupations. It turns out very few wealthy, well-educated men work in the bowels of fast food, and very few shopping cart handlers invest in stocks to any degree. While no studies exist to support this kind of detail, one imagines the most popular job description amongst stock market participants is “VP of something”.

Just being in the market carries a value added social cache on the greens or at dinner parties, and knowing the lingo is a secret hand shake of sorts on long, transatlantic flights in first class; “Our people are telling me I have to shift more trust liability into higher leveraged, off shore asset classes. Who do you like in Singapore?” If, on the other hand, the big guy in the center seat keeps saying “I gotta go to the can” all through the flight to St. Pete’s, odds are you are not in the markets.

In the end, stocks carry a degree of risk that most Americans prefer to avoid. The greater the degree of risk assumed, the greater the amount of the reward. In this fashion, not just stock market participation, but market profitability are tied to degrees of risk. Those willing and able to shoulder greater risk tend to consolidate and get wealthier, and at rates beyond those whose risk tolerance is just not up to it.

Economic Sociology tells us that both economic disposition and social strata are indicators of higher risk tolerance, and thus are rewarded more regularly with out sized checks. In essence, stinking rich folks can afford to take it in the teeth occasionally, however embarrassing that may be. Risk takes on another order of magnitude when the difference in a loss is between the polite tut tut’s at the club, and living in your minivan with the family. The opportunity to participate in risk is limited by the objective magnitude of failure.

Behavioural Finance suggests that risk tolerance is also governed by human foibles. Most small investors understand that the markets are a game fixed in favor of the Goliath and well connected. This keeps market participation to only the foolhardy, or as researchers have come to know them, gamblers. Gambling requires a certain set of unfortunate human traits; a taste for un-rational risk, and the sad affliction to always overestimate ability and profits, while to simultaneously ignore or rationalize away the losses. Finance is another sport where testosterone plays a deciding role. It’s a male thing.

Entry to Wall Street is barred to those without high levels of economic and social capital. The size and influence of that capital dictates the amount of risk aversion, and acts as a limiter on the opportunity to consolidate great wealth from the markets. In this way, free markets, capitalism, and liberal economics have fashioned a system of wealth and power that is increasingly oligarchic, self perpetuating, and completely undemocratic.

The staggering bull market just ended only served to speed up the process, as boom markets favour those who can push the limits of risk with mountains of capital. The limits of risk apparently being highly leveraged in a head scratching soup of acronyms, with absolutely no idea of what will happen if for once, you were wrong.

The brutal market collapse and general maelstrom of economic disarray in late 2008 laid bare the inequities of free market equity investing. The greater part of America that invested in the markets had their hopes and dreams shattered, and their ability to spend cauterized. That spelled job loss and eviction for the four fifths of the country that was living beyond their means, trying to keep up with a dream they were silently denied entry to, and dependent on the largess of the market investors seemingly endless disposable income.

For those who had the opportunity to take the biggest risks, and for whom those successive risks had ensured survival in an ever-decreasing club of consolidated wealth and power… they all took “haircuts”. For this elite class of investor, boom and bust did little more than jiggle about very big numbers on streams of personal financial statements. If you found you had to sell the home in the Hamptons in the worst real estate market in history, you were not in this class.

Far from spreading wealth, boom markets concentrate gain, and solidify ownership of America’s real power elite. In a crash, the process is the same but brutal, when those without the resources to stay the course and take real risk on recovery are shut out, or worse, lose all faith in the value of risk and the hopelessness of the Wall Street game.

When the Dow Jones Industrial Average rises, who does it benefit? Those with investments in the stock market, who have the social standing and resources to accept the risks that reward so few. The great balance of traders – small, individual traders alone or in groups – can seldom do any better than average – and average barely keeps ahead of inflation. For the two thirds of Americans not in the markets at all, it hardly matters a whiff.

There is nothing democratic about “the markets”.

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