Tim Bennett looks at why the number of firms listed on one of the world’s most important stock markets is falling and explains what it means for investors
Why is the US stock market shrinking?
Here’s a puzzle. Whilst the total number of firms listed globally has never been higher, thanks largely to the rapid expansion of stock exchanges in Emerging Markets, the number of firms listing in the world’s largest economy – the US – is shrinking and has been doing so for some time. The key questions for investors are why and the implications of this trend for global portfolios.
The shrinkage is undeniable
Here are some eye-opening statistics;
- Although the value of US listed firms has been rising steadily for years, the Wiltshire 5,000 – one of the broadest representations of the US market – contains only around 3,600 firms
- The number of US companies as a whole has fallen nearly 40% since 1997
- There have not been fewer listed US stocks since 1984
What this reveals is that an ever-decreasing number of large firms dominate the US listed market and that this is a well-established trend. So what’s going on?
Why this is happening
There are two sets of forces at work that are causing this decline in numbers.
1. The laws of the corporate jungle
Firms have always disappeared from public markets when they are taken over, or merge with other firms. There is also a natural attrition that occurs when firms shrink down to a size that no longer qualifies them for a listing, or they simply go bust and disappear. However, none of this is new – another important factor is the key.
2. Fewer firms want to be listed
The reasons why some firms are now choosing not to come to public markets in the US vary. Some entrepreneurs fear the level of regulation and media scrutiny that comes with a listing. Others worry that once they list, they will come under intense pressure to deliver over very short-term time horizons. Then there are the CEOs in sectors such as technology who simply don’t see the point of a listing when they can raise capital from private equity and venture capital firms instead, well away from public markets.
Why this matters
The reasons why this trend is a cause for concern can be summarised as follows;
In summary, critics worry firstly that power is being concentrated in fewer and fewer hands on public exchanges as the average size of a listed firm grows. This is not necessarily a positive trend as far as consumers or shareholders are concerned. Furthermore, the fact that certain sectors are, in effect, under-represented on public markets means that investors, both institutional and retail, are being excluded from fully participating in their development and may, as a result, struggle to achieve balanced, diversified portfolios that truly represent the underlying economy. Then there are those who argue that by staying “off-market” large firms are not being subjected to proper scrutiny and discipline as they would were they listed, and that the concept of a shareholders’ democracy is being weakened as a result. Lastly, there are those who fear that what has begun as a trend in the world’s largest market – the US – will inevitably ripple out to other bourses, particularly the older, more established ones.
What can we do about it?
For investors this trend has at least two implications. First, relying on broad indices as a full representation of the underlying economy looks increasingly unwise in the US. How, for example, can investors be sure that the technology weighting ascribed to a US exchange traded fund fully represents the influence of that sector in the US economy? Next, this trend underscores the importance of international portfolio diversification to ensure that an investor is not inadvertently over-exposed to the listed firms and/or sectors that increasingly dominate Western bourses. Thirdly, large investors, in particular, should ensure that they are holding the Boards of the stock market giants properly to account since our overall faith in public markets is now heavily tied to the success, or otherwise, of the firms they run.