Financial sector has a duty to investors and the economy to break the cult of equity

Egged on by free-market ideologues, stock markets have funnelled too large a portion of savings into a too-narrow base of investments
The financial sector must find new ways to deploy the funds it collects in great quantity but often wastes through a myopic focus on short-term gains

Anthony Rowley

Published: 10:30pm, 11 Feb 2023

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Is it time to drain the stock market swamp or, more euphemistically, the great lake of stock market liquidity that has swollen in size on the back of unquestioning investor faith in what former US president Ronald Reagan referred to in 1981 as “the magic of the marketplace”?

It could be, for the benefit of myriad savers who have been lulled into thinking that financial wizardry could turn gambling into science and base metals into gold. They might have been better off putting hard-earned savings into more pedestrian but less volatile forms of investment.

Stock market players still await the return of the great magician who can conjure up fresh exotica to replace fallen tech and other glamour stocks, even though the world seems to lurching closer to conflict and where the only growth sector will be the armaments industry.

This disconnect should alert us to the frequent inability of stock markets to distinguish fantasy from reality. It should also counsel withdrawal from investments that are more likely now to sink along with the economy into recession than to rise phoenix-like from the ashes of a bear market.

Put simply, it means stock market investors – which most people are nowadays, either voluntarily through buying shares or involuntarily by contributing to pension funds and mutual funds – might need to stop increasing their holdings or even divest until alternatives appear.

This is not an overly savage indictment of stock markets, which do have their uses. It is simply to question the unthinking cult of equity which, egged on by free-market ideologues, has funnelled too large a portion of savings into a too-narrow base of investments.

For example, massive areas of the global economy such as fighting climate change, constructing basic infrastructure and expanding health services often go dangerously underfunded from public and private sources while surplus liquidity drives stocks to unsustainable pinnacles.

A few figures help put this imbalance into perspective. The size of the global economy is roughly US$100 trillion, according to the World Bank. Yet some stock markets, notably in Western economies, tower in size above that level.

In the United States – as might be expected in the bastion of market capitalism – stock market capitalisation is almost twice the size of the economy, according to World Bank data. In Canada, the ratio of market cap to GDP is 160 per cent, in Australia it is 130 per cent and in Britain, it is 108 per cent.

The power of stock markets in these countries to move the economy by absorbing savings and through swings in value is clear. Much the same applies in parts of Asia – notably Japan, South Korea and Malaysia – although, in China, the stock market is considerably smaller relative to the size of the economy at 83 per cent.

A man walks past an electronic stock board showing Japan’s Nikkei 225 index, at a securities firm in Tokyo, on February 9. Photo: AP

Some Asian countries did try to resist the explosion of stock markets in the past but nevertheless had markets thrust upon them by European countries and the US or through pressure from the World Bank during the “emerging markets” movement of the 1970s and 1980s.

One case in point was Indonesia. One high-level source in the World Bank Group recounted to me how Jakarta’s request for help in improving its banking system at that time was overridden by a Washington which was then intent on spreading the gospel of stock markets and liberal economy.

Generally speaking, the countries of Southeast Asia have not allowed the growth of their stock markets to reach the towering proportions of those in Western countries. Nevertheless, the Asian financial crisis of 1997 showed how vulnerable to stock market shocks the region has become.

Whether the development of equity markets is best suited to meet the broad economic development needs of countries in Asia or other developing regions – or of advanced Western economies, for that matter – is worthy of deeper study, given the power that markets have to move economies rather than vice versa.

Money managers might not welcome a debate. The size of the fund management industry argues against it. According to Statista, assets under management where professional managers charge fees for their services reached US$112 trillion in 2021, half of that being in North America.

The size of this colossal pot of assets is expected to reach US$145 trillion by 2025, according to consultancy PwC, roughly in line with the projected growth of GDP. That will be the case unless new forms of investment vehicles and public-private partnerships can change the historical trend.

Wind turbines stand tall in Livermore, California, on August 10, 2022. The World Bank and the Asian Development Bank have launched programmes to help fund the transition from a “brown” to a “green” global economy. Photo: AP

This is beginning to happen, for example in the area of climate change. In a departure from its former strong advocacy of private-sector initiatives, the World Bank is now promoting public-private investment vehicles via its Scale programme (Scaling Climate Action by Lowering Emissions), as is the Asian Development Bank via its Energy Transition Mechanism initiative.

The financial sector in general and asset managers in particular have a duty to investors and to the economy. They need to devise new, broader ways to deploy the funds that they collect in great quantity but often waste through a myopic focus on short-term gains.

Unless this happens, governments will be forced to collect, in the form of higher taxes, some of the trillions of dollars of savings that presently pass through the hands of fund managers. Either that or banks and bond markets will need to assert ascendancy over equity markets.

Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs

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