Fund managers have a hard time beating the market because the number of stocks to choose from has collapsed in the past 20 years, according to Jason Zweig, investing columnists at The Wall Street Journal.
“More money chasing fewer stocks could lead some fund managers to buy indiscriminately, regardless of value,” he said. “Investing in some of the market’s trendiest strategies might be less profitable in the future than they looked in the past.”
Twenty years ago, 7,355 U.S. companies were publicly listed, according to research cited by the newspaper. That number has dropped to fewer than 3,600.
Some market benchmarks are misnamed. The Russell 2000 index of smaller companies only has 1,436 stocks, according to a list on CNN Money.
“Several factors explain the shrinking number of stocks, analysts say, including the regulatory red tape that discourages smaller companies from going and staying public; the flood of venture-capital funding that enables young companies to stay private longer; and the rise of private-equity funds, whose buyouts take shares off the public market,” Zweig said.
The fewer number of stocks means that it’s harder for fund managers to find companies that are neglected by investors. There are more analysts studying the same stocks.
Surviving public companies tend to be “fewer, bigger, older, more profitable and easier to analyze,” according to Michael Mauboussin, a strategist at Credit Suisse in New York.
Only five stocks are driving the stock market to record highs this year: Apple, Alphabet, Microsoft, Amazon and Facebook. If one those companies sees a slowdown in sales or disappoints investors, broader market indexes like the Nasdaq Composite will suffer.
For years, analysts have described investor disenchantment with stocks, especially after the collapse of the dot-com and subprime asset bubbles quickly destroyed wealth that had taken years to build up.
Seven years ago, Citibank’s Robert Buckland pronounced that the “equity cult” was dead as institutional investors like pension funds allocated more money to bonds and other investments.
"It has taken 10 years, and two 50% bear markets, to reverse this cult,” Buckland wrote in September 2010. “European and Japanese equities are already trading on dividend yields above government bond yields. U.S. equities are almost there as well. An immediate reincarnation of the equity cult seems unlikely. Global corporates, especially the mega-caps, rushed to exploit cheap financing as the equity cult inflated. They have been slow to redeem equity now that the cult has deflated. Equity oversupply remains a drag on share prices."
The S&P 500 has more than doubled since Buckland declared the end of the equity cult, but central banks have been buying trillions of dollars of assets in an effort to combat price deflation. Stocks are the most expensive they’ve been since the dot-com bubble. The next recession will be the hardest test of their willingness to bail out investors.
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