Similarly, investing is not a “zero-sum” game either.
Interesting point of view. I agree that Enron gains may not come at the expense of BP shareholders but where did they come from? It seems to me that every dollar made in the stock market must come at the expense of someone else unless dollars are magically created out of nothing somewhere in the process.
Mike
· 3 years ago
That "magic" is exactly the basis for all economies - the creation of wealth. We could all, in theory, produce everything we needed to sustain and enrich our own lives - food, clothing, shelter, and entertainment. It works better, though, for each of us to focus on one or a few particular things we're good at, and trade those for something that other folks are good at. A single farmer, specializing, can produce food large numers of people, whereas that same number of people farming for themselves would produce much less. There remains waste, inefficiency, and fraud, but those tend to be minor factors in healthy economies.
The same applies to the stock market. A dollar flowing into the market is an investment; on average, that dollar grows because it is used to fuel economically productive activity. That's the "magic" that creates dollars. Some companies fail, but on average the value of the stock market grows because of the wealth that its companies create.
We now know that Enron was an exception. It created no net wealth, but instead was an example of waste and fraud. Many people lost the money they put into Enron; but if they bet across the board on the economy they could be showing a net gain at this point.
robert108
· 3 years ago
MikeA: What Mike said. This is a fundamental difference between socialist econ and the free enterprise variety. If your premise were true, then every rich person got that way by taking something away from someone else. It's a "fixed pie", right? If that were true, Karl Marx would be a genius. In fact, it hasn't been true since the Industrial Revolution, when we invented manufacturing to replace handicrafts. We constantly create value, so that everyone can be wealthier the next moment, if they do what is necessary to do so.
MikeAdamson
· 3 years ago
Mike and r108...thanks for your interesting points on the genius of free markets. ;) I certainly agree that free market activity (the capitalist model) creates a bigger pie rather than merely splitting a static pie but I believe Bat1 is discussing investing and his examples highlight investing in the stock markets. The stock market is certainly not unrelated to the economy but it really is a different animal as I'm sure you will agree that it is an exchange mechanism i.e. I sell my shares to r108 and Mike sells his shares to me. All money within the system is brought into the system by an actor...no money is created through the exchange of shares. If I make $5 then there is an offsetting loss of $5 somewhere...not counting transaction costs of course.
N'est pas?
robert108
· 3 years ago
MikeA: You make some good points, but not all. I am bothered by one of your points, and have been for some time: The stock market, in and of itself, does not increase value. That doesn't make it a zero-sum game, since the spinoff is increased investment, which ultimately creates prosperity. It doesn't directly create prosperity, though. On one level, the stock market, as a whole, goes up when more stocks are sought than are offered for sale, conversely, when more stocks are offered for sale than are wanted at that moment, the market goes down. As such, it is the epitome of a free market. What you are doing when you are investing in the "stock market" in general is that you are investing in the continuing prosperity of the free enterprise system in the US. When you invest in any particular stock, you are investing in the financial health of that company. The Macrocosm is the aggregate of all the microcosms.
So, when I make $5 on a share of stock, no one has to lose $5 somewhere. More people wanted to buy the stock than wanted to sell it. The reason or reasons for that could be anything from sound business reasons to the phase of the moon. That is the gambling part.
MikeAdamson
· 3 years ago
The stock market, in and of itself, does not increase value. That doesn't make it a zero-sum game, since the spinoff is increased investment, which ultimately creates prosperity. It doesn't directly create prosperity, though.
I'm not following you r108. I'm not sure what you mean by "value" in terms of the stock market (money?) and you haven't explained how my gain of $5 does not come at the expense of another. Where did that $5 come from if not from another participant in the market?
Bat One
· 3 years ago
First, I believe that in his original comment, MikeA mistakenly wrote Enron, rather than Exxon. That should make the rest of his comments somewhat easier to understand. Now, that is not to say that the case of Enron is not important. It most certainly is. But my original post referred back to earlier comments by a number of us about having made money on the rise of Exxon stock.
MikeA,
It might help to get beyond the notion that the economy creates money. It doesn't. The economy, including the various markets (NYSE, NASDAQ, CBOE, etc.) creates wealth. And that is not the same thing as money. Money is how we measure wealth, or value, but it is nothing more than an artificial storehouse and a medium of exchange for value or wealth. As, for example, is a check, or the electronic impulses that zip back and forth when you use your debit card to buy lunch for yourself and your wife/girlfriend/secretary/main-squeeze.
Ultimately, any asset is worth not what you paid for it, but what someone else is willing to pay you for it. Shares of stock, T-bills, municipal bonds, a house, an office building, an ounce of gold, a bushel of soybeans, a hunderedwieght of porkbellies, or an "allotment" of 500,000 barrels of Iraqi oil, all are worth only what someone is willing to pay for them. And bringing the seller and the buyer together, that's the function of a market.
robert108
· 3 years ago
MikeA: Sorry about the unclarity. I shouldn't have put the two statements together, thus implying that they were related. They aren't. Bat has clarified the issue as being between wealth and money. If your stock goes up $5, it is not necessary for anyone else's stock to go down $5; the entire value of the market can go up, due to the creation of value in the economy, which is the basic point. Things are ultimately worth only what someone else will pay for them.
My own take on Enron(not Exxon) is that no one knows the real price of energy, since it has always been a govt-subsidized monopoly. Therefore, the ultimate value of Enron stock was always unknown, so how could anyone reasonably trade in it? I never considered it a good investment, so it had no value for me. A lot of people did, though, and that is why it's a free market. People are free to invest or not, as they wish, and they may profit or lose. Degree of risk=amount of return if you are right. In my mind, Enron was a sure loser.
Mike
· 3 years ago
MikeA said, "All money within the system is brought into the system by an actor...no money is created through the exchange of shares.... I'm not sure what you mean by "value" in terms of the stock market (money?) and you haven't explained how my gain of $5 does not come at the expense of another. Where did that $5 come from if not from another participant in the market?"
It appears, M.A., that you are conflating the ideas of "dollars" in the market with "value" in the market. Let's take a hypothetical widget company whose business grows steadily and honestly from day one. I buy the IPO for $5/share. I later sell my stake for $10/share to you. You, in turn, sell the stock to a third party for $15/share.
Who's won and who's lost? It depends. If the company is doing well, its success creates the value represented by the share. If I bought a stock worth $5 by paying 4%, then I have lost nothing. If it's worth $10.00 when I sell it to you, I have gained but you have not lost. If it's worth $15 when you sell, you have gained but your buyer has not lost.
We only "gain" or "lose" if the underlying value of the stock decouples from what we have paid for it. Even though we bring our dollars into the market to purchase the stock, the underlying value is creating by the successes and failures of the company issuing the stock.
By contrast, if I sell you the stock for $10/share, and the company loses half its value due to crushing competition, you may have lost relative to your purchase price, but your loss has little to no relation to my gain (unless I have insider information - fraud).
Final scenario. I buy at $5/share. You buy, not from me, but direct from the company, a new issue, at $10/share. Third Party buys another re-issue from the company at $15/share. The company takes our collective $30 and invests it in more efficient widget production, improving its bottom line and increasing the value of the company. We all sell our stock for $20/share - the current actual value. We've all gained, but no one has lost.
In fact, true "investment" is always a non-zero-sum game, a win-win situation, because of that very effect. It's speculation - betting that a stock is under- or over-valued based on market inefficiencies - which is a zero-sum game. Day trading is a great example of this.
robert108
· 3 years ago
Great post, Mike. One small quibble from a few posts back: Money is also a store of value.
MikeAdamson
· 3 years ago
Bat One...Exxon not Enron. Sorry about that.
r108 said
Things are ultimately worth only what someone else will pay for them.
No argument here.
the entire value of the market can go up, due to the creation of value in the economy, which is the basic point.
Big argument here. There is a relationship between the markets and the economy but the value of the market is the value that the buyers and sellers place on it. The markets tend to move before changes in the economy become evident so to say that the creation of value in the economy causes the creation of value in the markets is wrong. The best you can claim is that the perception of the market participants of how the economy will perform impacts on the value the paticipants place on the market.
If your stock goes up $5, it is not necessary for anyone else's stock to go down $5;
If I sell my stock for a $5 gain then somebody else has booked or will book a $5 loss less transaction costs. Stock market transactions to not create wealth...they transfer wealth from the losers to the winners.
MikeAdamson
· 3 years ago
Mike said
Even though we bring our dollars into the market to purchase the stock, the underlying value is creating by the successes and failures of the company issuing the stock.
I understand what you are saying but the "value" of a stock is the "money" that the buyer is perpared to pay for it. I am a value investor myself and I look for stocks that I feel the market has priced lower than the company fundamentals suggest it should. I've done quite well if I do say so myself but the fact remains that a stock can be grossly undervalued IMO but the market may never come to agree with my valuation and thus the bottom line is that the stock is worth what the buyer will pay. If we are discussing stocks then we must decouple the market price from the underlying value because any relationship between the two must be confirmed by the market participants through the transaction.
As for your final scenario...the three of us are in the happy position to have all made money. Perhaps the folks we sold our shares to will turn out to be the losers or perhaps they'll make money as well and it's the next buyers who end up with the hot potato. There will be a loser though because there are no free rides and there is no "value" created by our transactions. The company creates "value" but the trading of its stock does not.
and finally
In fact, true "investment" is always a non-zero-sum game, a win-win situation, because of that very effect. It's speculation - betting that a stock is under- or over-valued based on market inefficiencies - which is a zero-sum game.
I acknowledge that this is a popular view among market observers but it just isn't true. The stock market is based on the perceptions of the participants...perception of the economy and of individula stocks. There is no causal relationship between the economy and the stock market beyond any impact brought to bear by perception.
And I must say that it's nice to discuss something without all of the histrionics...kudos to us all.
robert108
· 3 years ago
MikeA: If you sell your stock for a certain amount of money, you have that amount of dollars, and the person who bought it from you has a piece of paper. If you both don't think you got a good deal, the transaction doesn't take place. This is always true in the free enterprise system. No loss is involved. The entire market can go up; every stock can increase in value. Every stock can also go down in value. Neither of those is statistically likely, but both are possible. The assignment of value is subjective, as you point out, but you are in error that there is no connection at all with the creation of value in the economy. It isn't a point by point, direct connection. In 1929, for example, the entire market crashed, and every stock went down in value. This was due to a drop in demand for stocks, which hampered the creation of value in the economy. The continuing lack of confidence in the stock market resulted in a downward slide that reached its low point in 1935. From there it slowly rose until WWII started.
To clarify one other point. If I buy a stock at $15 and it goes to $20, and I sell it to you at that point, I have made $5 on that share. You break even on the sale, with the expectation that it will continue to increase. No loss is involved. If the stock drops, you only lose money on the deal if you sell; if you hold on to the stock until it goes up again, you recoup your losses and maybe, if it goes up past $20, you will also make money on the deal, but only when you sell it to someone else.
robert108
· 3 years ago
MikeA: One more thing: the market may move either before a move in the economy, at the same time, or afterward. There are no rules; that's the great thing about it.
MikeAdamson
· 3 years ago
If I buy a stock at $15 and it goes to $20, and I sell it to you at that point, I have made $5 on that share. You break even on the sale, with the expectation that it will continue to increase. No loss is involved. If the stock drops, you only lose money on the deal if you sell; if you hold on to the stock until it goes up again, you recoup your losses and maybe, if it goes up past $20, you will also make money on the deal, but only when you sell it to someone else.
The sentence I've bolded is true. I think your error is highlighted in the next sentence. If the stock price goes up forever then I agree that there are no losers but that hasn't happened yet and I choose not to accept that possibility on faith. The share in a company has no intrinsic value, other than dividends it might pay, until the share is sold. In order to make money I must buy and sell and use the proceeds for whatever purposes I dictate. The share has a paper value i.e. what someone would pay for it at a given time but it has no value in and of itself until I sell it thus completing the transaction.
Yes, the market and all of its constituent shares can go up and down in unison but the value going up and down is on paper only. Once I sell the share then I can determine whether I have won or lost on that stock and if I can win enough of those individual stock transactions then my portfolio will increase.
You still haven't explained how a gain in the market is not offset by a loss in the market and that is the crux of our disagreement. Where did my $5 gain come from?
bullwinkle
· 3 years ago
That's simple, if one person buys a share of stock for $15 and sells it later to another for $20 the $5 came from the other person. That person set the value and had the option to buy it or not. Unless he stole the money that $5 over and above what the original owner paid came from the labor of the second person. He paid a price he saw fit so nobody lost anything, if he sells it later for he'll lose the difference.
bullwinkle
· 3 years ago
That should read "if he sells it later for less he'll lose the difference".
robert108
· 3 years ago
MikeA: The market is an investment market, not a quantity one. Even the commodities markets(like the oil market) are on projected future value, not the present value of the actual commodity. I have explained it to you every way I know how to explain it. Each stock is an individual matter; they don't relate to each other in terms of value. The overall value of the market reflects, roughly, the value of the overall economy, but any individual stock may increase or decrease in value independently of the performance of the company who originally sold the stock. The market is independent of the businesses in that way. If all stocks go up, they do not do so in unison, as you stated; they are all individually responding to activity in the market. As I said before, it is possible but statistically unlikely. I say again, the $5 you made came because more money was offered for that stock than was available the day before. There are trends, but no individual move is predictable beforehand, unless you have insider information, and that isn't always accurate, either. The value of anything in this system is entirely dependent on what someone is willing to pay for it at the moment of sale. It's all on paper until you buy or sell. It is transactionally determined, and that is the only factor in stock prices. No stock has any intrinsic value.
bullwinkle: Not true. The $5 came from an increase in the perceived value of that stock that day. More people wanted to buy the stock than wanted to sell it that day. No labor is involved in this transaction. The stock values are strictly transactionally determined; nothing else is involved. The stock market has its own reality.
Bat One
· 3 years ago
MikeA,
To use your example, the person who buys your single share of stock for $20 (market specialists aside) thinks that the individual share of stock that you are selling to him is worth $20. He is unaware of what you paid for that share. For all he knows, you could have bought it last month for $15 or five years ago for $1. The price you paid is not part of the calculation. Nor is your reason for selling. You could be tryng to raise cash for other purposes. You could be selling because you have another opportunity elsewhere. It could be for tax purposes. Or you could be sellling out of a retirement account because government regulations on such accounts require the sale. The buyer cares about neither your reason for selling nor the price that you paid.
And just as your gain of $5 wasn't realized until you actually sold the share, he is no better or worse off with the purchase... until, of course, he sells the share himself and realizes any gain or loss on that transaction.
Carrick
· 3 years ago
MikeA:
You still haven't explained how a gain in the market is not offset by a loss in the market and that is the crux of our disagreement.
Actually I think they have (companies generate wealth), and I think your response was along the lines of "I refuse to believe that".
Companies sell public shares ("stocks") so that they can turn around and invest in their company... over time this makes the company, and shares of that company, more valuable ("wealth is created"). On average, they increase in value about 10-12% per year.
In the real world there are very few long-term zero-sum games. From a physics standpoint, "zero-sum games" are only possible in a strictly linear system. Since the stock market is non-linear (as is any physical system with feedback), the zero-sum game is strictly impossible, given a sufficiently long transaction period.
Your scenario may actually hold if one person buys a stock in the morning, then sells it in the evening. If he waits 10 years before selling it, then on average both parties will make money... especially if they're smart enough to diversify their holdings.
This isn't exactly a new scenario. It's being going on since publically owned companies (roughly the 14th century, I believe).
Bat One
· 3 years ago
MikeA,
If it helps any, try substituting a house for that share of stock. Leave out the financing (pay cash) and the situation, while simpler, is virtually the same. Your profit comes when you sell the house, but the person who buys it from you has lost nothing. He has merely transferred some of his wealth/value from his bank account to you in exchange for the house which is valued at whatever price HE paid for it.
Your gain does not equal his loss.
MikeAdamson
· 3 years ago
Bat One says And just as your gain of $5 wasn't realized until you actually sold the share, he is no better or worse off with the purchase... until, of course, he sells the share himself and realizes any gain or loss on that transaction.
Exactly...but that doesn't explain why investing is not a zero sum game. If I make $5 buying and selling a stock then that $5 has to come from somewhere.
MikeAdamson
· 3 years ago
Bat One...if the buyer keeps the horse until it dies then I can see your point. You can't ride a share though and so to extract the real value from it you must sell it.
Carrick
· 3 years ago
MikeAdamson:
If I make $5 buying and selling a stock then that $5 has to come from somewhere.
It does. From the creation of new wealth.
Wealth gets created all of the time. Compare your home to one of your distant anscestors... you know, the guys with the cave & the open fire pit. Obviously there was something more than a zero sum game to go from that lifestyle to the modern one.
This seems so obvious, I'm having trouble seeing what you don't understand.
Bat One
· 3 years ago
MikeA,
Again, the extra $5 comes from the person who bought the stock from you. And because he valued that share of stock at $20, he is now richer and no poorer for having bought it. He merely transferred $20 of his wealth to you in exchange for a $20 share of stock. The value of that single share of stock is determined by the last transaction in which it changed hands. It may be worth more or less to someone else at any particular point in time, but its only true value is what the last purcahser paid to acquire it.
Bat One
· 3 years ago
Carrick,
I just can't wait for the seminar on margin accounts.
Carrick
· 3 years ago
Here's a fun link to the application of physics to financing. It addresses form a realists perspective why finance (and so much else of life) is not zero sum.
MikeAdamson
· 3 years ago
Here are four links to articles that take my side of the argument. Let me reiterate that I know that there is another side, the side you are all taking,and that your argument is widely held...but it is still wrong in my opinion. Skim through each article and read the stuff on zero-sum if you're interested.
Carrick is right when he says that your points have been explained and that what I'm really saying is that I don't buy it. I fail to see any causal link between the performance of the economy and the performance of the stock market other than that which can be chalked up to investor perceptions of each.
MikeAdamson
· 3 years ago
Carrick...good article but I think you're missing my point. I am not talking about the economy or about people's wealth...I am talking about the stock market and only the stock market. Shares represent ownership in a business but they hold no intrinsic value in themselves. I can't ride them, I can't live in them, I must sell them to realize value.
While the number of shares outstanding in any market changes due to new issues,cancellations etc. the fact remains that the total number of shares transacted at any single moment can not exceed the number of shares outstanding at that same moment. Some shares will be more popular and thus rise in price and others less so thus declining in price but taken in the aggregate...the buying and selling of shares is limited to the aggregate number of shares issued at any single time. If this makes sense then maybe I can move on to another point.
Bat One
· 3 years ago
"I fail to see any causal link between the performance of the economy and the performance of the stock market other than that which can be chalked up to investor perceptions of each. "
MikeA,
May I assume that we have put the question of the $5 sock profit to rest... at least for the time being? Because the question you raise now, about the relation between the stock market and the economy, is on a whole different level. And while I'm perfectl;y willing to discuss it, with you and Carrick, or Robert108, or anyone else, it will have to wait til tomorrow.
MikeAdamson
· 3 years ago
Bat One...I only raise the economy connection because it has been offered as a source of the magic fiver. We can have at it tomorrow.
Bat One
· 3 years ago
Deal!!!
robert108
· 3 years ago
MikeA: The stock market is the way it is because it was created to be that way. It's not about rules or opinions or theories; it's just the way it is. It has no intrinsic value, so that the transactions are the bottom line. It is the purest form of free enterprise on earth. Those pieces of paper are worthless on their own, they have no value independent of the market. The market roughly follows the overall economic value of the economy because the market is based on the perception of the place each one of those companies holds in the overall economy. It doesn't matter if you agree or disagree. If you want to understand and use the stock market, you have to recognize what it is.
Carrick
· 3 years ago
MikeAdamson:
I fail to see any causal link between the performance of the economy and the performance of the stock market other than that which can be chalked up to investor perceptions of each.
Stocks are holdings of a fraction of the value of a company. As the economy grows, the values of the companies in that economy grow. Hence the value of the stocks---the individual holdings in those companies--- also grows.
There's the connection. I don't see how any amount of philosophical musing can eradicate it, either.
Nor can the point I made: Namely, zero-sum implies conservation, and conservation requires a linear system. That's a mathematical argument that's immutable under any amount of hand-waving argumentation.
Some people (on the non-zero sum side) have evoked inefficiency, because that's another mechanism for non-zero-sum, but that would not explain an increase in wealth over time.
An increase in wealth occurs because there is a feed-back loop between investment and the resulting value of the company.
As for your links:
William Sharpe is not arguing for zero-sum economics. He is arguing in favor of passive managment over active management, whether correctly or not is irrelevant to the current discussion. Clearly he accepts that the market increases in value over time.
The link to Charles Ellis has nothing to say about zero-sum economics. He merely makes the point that index funds--which spread risk over multiple companies---are more predictable in their growth than purchases of individual stocks. See Warren Buffet for a counter to his arguments (the "knowledgable" investor), but this is entirely orthogonal to our discussion.
The third link actual is about trading of securities being a zero-sum game. It contains a lot of descriptive language about skilled versus unskilled traders, but contains zero facts demonstrating the zero-sum nature of the market. Indeed, his main thesis---skilled traders get their profit from unskilled traders---does not require a zero sum game!
If you are just trying to tell us that unskilled traders can lose their investment... well, duh! That doesn't prevent the market in the long term from being non-zero sum. Obviously some people lose money in the short run. That's why they say, if you invest in the market, count on leaving your funds there for at least 10 years.
Link four--devoid of any facts demonstrating that trading is a zero-sum game.
Bottom line, mathematics demonstrates that the market cannot be truely zero-sum. (Again, in the long term, you have to wait long enough for the money to circulate to get a feedback. Short-term it could be linear and therefore zero-sum.) No amount of rhetoric can change that fact.
MikeAdamson
· 3 years ago
r108 says
If you want to understand and use the stock market, you have to recognize what it is.
Yup. I am quite comfortable with my understanding of the stock market although there's always something new to learn about anything.
Carrick
· 3 years ago
MikeA:
Shares represent ownership in a business but they hold no intrinsic value in themselves.
Why would you say they have "no value"? That's crazy talk. The company's obviously worth money, you own a percentage of the company, so your share is worth money.
You have to sell it to turn it into something convertable, but that is a completely different statement that "they have no intrinsic value" in themselves. Of course they have intrinsic value, otherwise nobody would buy them from you.
robert108
· 3 years ago
People buy stocks because they think they will be worth more in the future. People sell stocks because they think they will be worth less, or that the increase will be less than some other investment. Even though you can express a total number of shares in the market, their worth is a matter of the relationship between supply and demand at any particular moment.
Carrick: "no intrinsic value" means that they are only worth what the market says they are. If the company goes out of business, they are worthless, except for antique value in a collector market. That is also a matter of supply and demand.
MikeAdamson
· 3 years ago
Carrick
William Sharpe is not arguing for zero-sum economics.
Nor am I. I freely acknowledge that wealth exists and that it tends to grow over time. That said, the stock market is not the economy or vice versa.
I'll even grant that the nominal aggregate value of the stock market increases over time but this is due to the influx of new money into the market and not because the stock market has created "value" per se.
I sense your frustration with my position and believe me that I'm just as frustrated with your's. An economy can grow and the companies functioning in that economy can grow and the companies are generating more wealth if the economy is growing...I accept this. The economy grows and individuals become wealthier and the stock market goes up. When the economy slows the stock market slows and even declines...I accept this. You're missing the intermediate step...the stock market goes up because the participants believe that the shares are worth more and goes down because the participants believe that the shares are worth less but there is no automatic link betweeen the economy and the market.
The reason that the stock market has gone up over time is because the economy has created more wealth, a portion of which is directed into the stock market. The market itself doesn't create the wealth, it attracts the wealth and distributes it amongst the market participants.
MikeAdamson
· 3 years ago
Carrick...you can't eat a share, you can't live in a share, you can't ride a share, you must sell the share to realize its value. The share itself represents something else and holds value to others for what it represents but it doesn't have value in itself....except as wallpaper of course.
MikeAdamson
· 3 years ago
r108 says
Even though you can express a total number of shares in the market, their worth is a matter of the relationship between supply and demand at any particular moment.
Now we're getting somewhere. What you say is true for individual securities but not for the market as an aggregate. The value of Exxon will vary based on supply and demand but the value of the aggregate market increases only when more wealth is injected into the stock market. This is why the market goes up when the economy grows...the economy is creating more wealth and thus more resources are directed to the market. All of this says nothing about the internal workings of the market however...the market isn't creating value just like the poker game doesn't create value. The market is a distribution mechanism.
Carrick
· 3 years ago
MikeAdamson:
You're missing the intermediate step...the stock market goes up because the participants believe that the shares are worth more and goes down because the participants believe that the shares are worth less but there is no automatic link betweeen the economy and the market.
I was waiting for this to show up. Really.
I think this statement is the crux of the matter, and gets into some pretty cool cognitive psychology. See The Wisdom of Crowds by James Suroweicki for a nie summary of the "state of the art" on this". The link is not automatic, but it nevertheless exists.
An individual makes a judgement about the value of a company (that is perhaps a better choice of words than "believes"). The average of the judgment of a group of individuals is approximately equal to the true value of that company based upon available information including the risks associated with what is not known.
One good analogy is "guess the number of jelly beans in a jar". If you take any single guess, you will get wildly varying answers, but when you average them, you get a very accurate count.
Carrick
· 3 years ago
MikeA:
The share itself represents something else and holds value to others for what it represents but it doesn't have value in itself....except as wallpaper of course.
By this definition, even a dollar has no value, since "it represents something else but doesn't have value in itself....except as wallpaper of course".
The reason that the stock market has gone up over time is because the economy has created more wealth, a portion of which is directed into the stock market. The market itself doesn't create the wealth, it attracts the wealth and distributes it amongst the market participants.
Which neglects the principle reason for the existence of public shares: The raising of funds by the company to grow the value of that company. To that extent, if no other, the market creates new wealth.
To demonstrate the validity of the rest of your statement, you would have to be able to show that the total value of the market equals the total amount of money invested into the market. Can you do this? It is a factual statement that should be provably true or false. If it is false, then clearly the market (even in that limited context) is not zero sum.
I would wager that the increase in wealth of e.g. the US stock market outpaces the amount invested in the market, due precisely because of the relationship between the shares in and actual value of a company.
robert108
· 3 years ago
MikeA: Nope. No wealth is "injected" into the stock market. The aggregate is the sum of all the individual buying decisions. The market exists because people want to invest in the future of business in this country. Their decision doesn't increase the value of the company whose stock is for sale; it increases the value of the stock itself. The relationship is there, but it's not one-to-one. Resources are not "directed" to the market independently of the aggregate buying and selling decisions. The market doesn't create value; the decision to buy creates value. If more want to buy than want to sell, value is created; if more want to sell then want to buy, value is lost.
robert108
· 3 years ago
Carrick: By capitalizing a company, a stock issue creates the possibility of new wealth, but that is up to management, product, marketing and efficiency of production, among other things. The value created in the market by the shares being traded after the IPO are dependent on how desirable that particular stock is, for any number of reasons. The company only gets the IPO value, plus any appreciation of the shares they may hold back.
Carrick
· 3 years ago
Robert108:
The market doesn't create value; the decision to buy creates value. If more want to buy than want to sell, value is created; if more want to sell then want to buy, value is lost.
I think this is true, but it skips the question of whether the market is rational. Clearly I am arguing that it is (on average at least). If the market were completely irrational (ie shares were not based at all upon the actual value of the company), I suspect you would get a random walk overtime in the value of the shares.
No doubt this explains some of the short term fluctuations of the value of a particular stock, but does not explain the longer, much smoother trends, which I believe are based upon an aggregate rational assessment of the value of the copmany in question.
Carrick
· 3 years ago
R108:
The company only gets the IPO value, plus any appreciation of the shares they may hold back.
Yeah, I knew that.
But the value obtained from the IPO is generally used to increase the value of the company. If there is a rational relationship between the stock value and the overall value of the company (I hold that on average there is), then this investment also increases the network of the shares of that company over time.
robert108
· 3 years ago
Carrick: Right. The "rational" part of the market is the people who hold stock; those that trade speculatively cause most of the radical and momentary fluctuations. All shares are not traded every day. The short-termers put their energy into the immediate supply/demand relationship, but the long-termers are interested in the overall performance of the company, and to some extent, the overall performance of the market over time.
You are also right about the use of the IPO; since a great many companies use the capital to their advantage, there is usually value created, but it's not guaranteed simply by the act of acquiring capital. One quibble: the IPO increases the value of the company temporarily; the long term increase is due to the effectiveness of the capitalization. Check out the Netscape IPO story sometime.
Carrick
· 3 years ago
Robert108, My weasel words were "on average" and "generally". But perfectly said.
An analogy is the homeowner who takes out an equity loan. Some of them squander it on things like a new car, others add new value to their home.
robert108
· 3 years ago
Carrick: Exactly. The very best use of home equity would be to invest it in a business; buying other property or in a separate business. Using it for home improvements isn't the best use of capital, economically, but it is very satisfying, emotionally for the homeowner and does benefit the home improvement business.
MikeAdamson
· 3 years ago
Ahem...you will be pleased to know that I no longer believe stock investing to be a zero sum game. I may provide some detail later but I did want to get my correction on the record.
You're still wrong about everything else of course. ;)
All Comments
Similarly, investing is not a “zero-sum” game either.
Interesting point of view. I agree that Enron gains may not come at the expense of BP shareholders but where did they come from? It seems to me that every dollar made in the stock market must come at the expense of someone else unless dollars are magically created out of nothing somewhere in the process.
That "magic" is exactly the basis for all economies - the creation of wealth. We could all, in theory, produce everything we needed to sustain and enrich our own lives - food, clothing, shelter, and entertainment. It works better, though, for each of us to focus on one or a few particular things we're good at, and trade those for something that other folks are good at. A single farmer, specializing, can produce food large numers of people, whereas that same number of people farming for themselves would produce much less. There remains waste, inefficiency, and fraud, but those tend to be minor factors in healthy economies.
The same applies to the stock market. A dollar flowing into the market is an investment; on average, that dollar grows because it is used to fuel economically productive activity. That's the "magic" that creates dollars. Some companies fail, but on average the value of the stock market grows because of the wealth that its companies create.
We now know that Enron was an exception. It created no net wealth, but instead was an example of waste and fraud. Many people lost the money they put into Enron; but if they bet across the board on the economy they could be showing a net gain at this point.
Mike and r108...thanks for your interesting points on the genius of free markets. ;) I certainly agree that free market activity (the capitalist model) creates a bigger pie rather than merely splitting a static pie but I believe Bat1 is discussing investing and his examples highlight investing in the stock markets. The stock market is certainly not unrelated to the economy but it really is a different animal as I'm sure you will agree that it is an exchange mechanism i.e. I sell my shares to r108 and Mike sells his shares to me. All money within the system is brought into the system by an actor...no money is created through the exchange of shares. If I make $5 then there is an offsetting loss of $5 somewhere...not counting transaction costs of course.
N'est pas?
MikeA: You make some good points, but not all. I am bothered by one of your points, and have been for some time: The stock market, in and of itself, does not increase value. That doesn't make it a zero-sum game, since the spinoff is increased investment, which ultimately creates prosperity. It doesn't directly create prosperity, though. On one level, the stock market, as a whole, goes up when more stocks are sought than are offered for sale, conversely, when more stocks are offered for sale than are wanted at that moment, the market goes down. As such, it is the epitome of a free market. What you are doing when you are investing in the "stock market" in general is that you are investing in the continuing prosperity of the free enterprise system in the US. When you invest in any particular stock, you are investing in the financial health of that company. The Macrocosm is the aggregate of all the microcosms.
So, when I make $5 on a share of stock, no one has to lose $5 somewhere. More people wanted to buy the stock than wanted to sell it. The reason or reasons for that could be anything from sound business reasons to the phase of the moon. That is the gambling part.
The stock market, in and of itself, does not increase value. That doesn't make it a zero-sum game, since the spinoff is increased investment, which ultimately creates prosperity. It doesn't directly create prosperity, though.
I'm not following you r108. I'm not sure what you mean by "value" in terms of the stock market (money?) and you haven't explained how my gain of $5 does not come at the expense of another. Where did that $5 come from if not from another participant in the market?
First, I believe that in his original comment, MikeA mistakenly wrote Enron, rather than Exxon. That should make the rest of his comments somewhat easier to understand. Now, that is not to say that the case of Enron is not important. It most certainly is. But my original post referred back to earlier comments by a number of us about having made money on the rise of Exxon stock.
MikeA,
It might help to get beyond the notion that the economy creates money. It doesn't. The economy, including the various markets (NYSE, NASDAQ, CBOE, etc.) creates wealth. And that is not the same thing as money. Money is how we measure wealth, or value, but it is nothing more than an artificial storehouse and a medium of exchange for value or wealth. As, for example, is a check, or the electronic impulses that zip back and forth when you use your debit card to buy lunch for yourself and your wife/girlfriend/secretary/main-squeeze.
Ultimately, any asset is worth not what you paid for it, but what someone else is willing to pay you for it. Shares of stock, T-bills, municipal bonds, a house, an office building, an ounce of gold, a bushel of soybeans, a hunderedwieght of porkbellies, or an "allotment" of 500,000 barrels of Iraqi oil, all are worth only what someone is willing to pay for them. And bringing the seller and the buyer together, that's the function of a market.
MikeA: Sorry about the unclarity. I shouldn't have put the two statements together, thus implying that they were related. They aren't. Bat has clarified the issue as being between wealth and money. If your stock goes up $5, it is not necessary for anyone else's stock to go down $5; the entire value of the market can go up, due to the creation of value in the economy, which is the basic point. Things are ultimately worth only what someone else will pay for them.
My own take on Enron(not Exxon) is that no one knows the real price of energy, since it has always been a govt-subsidized monopoly. Therefore, the ultimate value of Enron stock was always unknown, so how could anyone reasonably trade in it? I never considered it a good investment, so it had no value for me. A lot of people did, though, and that is why it's a free market. People are free to invest or not, as they wish, and they may profit or lose. Degree of risk=amount of return if you are right. In my mind, Enron was a sure loser.
It appears, M.A., that you are conflating the ideas of "dollars" in the market with "value" in the market. Let's take a hypothetical widget company whose business grows steadily and honestly from day one. I buy the IPO for $5/share. I later sell my stake for $10/share to you. You, in turn, sell the stock to a third party for $15/share.
Who's won and who's lost? It depends. If the company is doing well, its success creates the value represented by the share. If I bought a stock worth $5 by paying 4%, then I have lost nothing. If it's worth $10.00 when I sell it to you, I have gained but you have not lost. If it's worth $15 when you sell, you have gained but your buyer has not lost.
We only "gain" or "lose" if the underlying value of the stock decouples from what we have paid for it. Even though we bring our dollars into the market to purchase the stock, the underlying value is creating by the successes and failures of the company issuing the stock.
By contrast, if I sell you the stock for $10/share, and the company loses half its value due to crushing competition, you may have lost relative to your purchase price, but your loss has little to no relation to my gain (unless I have insider information - fraud).
Final scenario. I buy at $5/share. You buy, not from me, but direct from the company, a new issue, at $10/share. Third Party buys another re-issue from the company at $15/share. The company takes our collective $30 and invests it in more efficient widget production, improving its bottom line and increasing the value of the company. We all sell our stock for $20/share - the current actual value. We've all gained, but no one has lost.
In fact, true "investment" is always a non-zero-sum game, a win-win situation, because of that very effect. It's speculation - betting that a stock is under- or over-valued based on market inefficiencies - which is a zero-sum game. Day trading is a great example of this.
Bat One...Exxon not Enron. Sorry about that.
r108 said
Things are ultimately worth only what someone else will pay for them.
No argument here.
the entire value of the market can go up, due to the creation of value in the economy, which is the basic point.
Big argument here. There is a relationship between the markets and the economy but the value of the market is the value that the buyers and sellers place on it. The markets tend to move before changes in the economy become evident so to say that the creation of value in the economy causes the creation of value in the markets is wrong. The best you can claim is that the perception of the market participants of how the economy will perform impacts on the value the paticipants place on the market.
If your stock goes up $5, it is not necessary for anyone else's stock to go down $5;
If I sell my stock for a $5 gain then somebody else has booked or will book a $5 loss less transaction costs. Stock market transactions to not create wealth...they transfer wealth from the losers to the winners.
Mike said
Even though we bring our dollars into the market to purchase the stock, the underlying value is creating by the successes and failures of the company issuing the stock.
I understand what you are saying but the "value" of a stock is the "money" that the buyer is perpared to pay for it. I am a value investor myself and I look for stocks that I feel the market has priced lower than the company fundamentals suggest it should. I've done quite well if I do say so myself but the fact remains that a stock can be grossly undervalued IMO but the market may never come to agree with my valuation and thus the bottom line is that the stock is worth what the buyer will pay. If we are discussing stocks then we must decouple the market price from the underlying value because any relationship between the two must be confirmed by the market participants through the transaction.
As for your final scenario...the three of us are in the happy position to have all made money. Perhaps the folks we sold our shares to will turn out to be the losers or perhaps they'll make money as well and it's the next buyers who end up with the hot potato. There will be a loser though because there are no free rides and there is no "value" created by our transactions. The company creates "value" but the trading of its stock does not.
and finally
In fact, true "investment" is always a non-zero-sum game, a win-win situation, because of that very effect. It's speculation - betting that a stock is under- or over-valued based on market inefficiencies - which is a zero-sum game.
I acknowledge that this is a popular view among market observers but it just isn't true. The stock market is based on the perceptions of the participants...perception of the economy and of individula stocks. There is no causal relationship between the economy and the stock market beyond any impact brought to bear by perception.
And I must say that it's nice to discuss something without all of the histrionics...kudos to us all.
MikeA: If you sell your stock for a certain amount of money, you have that amount of dollars, and the person who bought it from you has a piece of paper. If you both don't think you got a good deal, the transaction doesn't take place. This is always true in the free enterprise system. No loss is involved. The entire market can go up; every stock can increase in value. Every stock can also go down in value. Neither of those is statistically likely, but both are possible. The assignment of value is subjective, as you point out, but you are in error that there is no connection at all with the creation of value in the economy. It isn't a point by point, direct connection. In 1929, for example, the entire market crashed, and every stock went down in value. This was due to a drop in demand for stocks, which hampered the creation of value in the economy. The continuing lack of confidence in the stock market resulted in a downward slide that reached its low point in 1935. From there it slowly rose until WWII started.
To clarify one other point. If I buy a stock at $15 and it goes to $20, and I sell it to you at that point, I have made $5 on that share. You break even on the sale, with the expectation that it will continue to increase. No loss is involved. If the stock drops, you only lose money on the deal if you sell; if you hold on to the stock until it goes up again, you recoup your losses and maybe, if it goes up past $20, you will also make money on the deal, but only when you sell it to someone else.
If I buy a stock at $15 and it goes to $20, and I sell it to you at that point, I have made $5 on that share. You break even on the sale, with the expectation that it will continue to increase. No loss is involved. If the stock drops, you only lose money on the deal if you sell; if you hold on to the stock until it goes up again, you recoup your losses and maybe, if it goes up past $20, you will also make money on the deal, but only when you sell it to someone else.
The sentence I've bolded is true. I think your error is highlighted in the next sentence. If the stock price goes up forever then I agree that there are no losers but that hasn't happened yet and I choose not to accept that possibility on faith. The share in a company has no intrinsic value, other than dividends it might pay, until the share is sold. In order to make money I must buy and sell and use the proceeds for whatever purposes I dictate. The share has a paper value i.e. what someone would pay for it at a given time but it has no value in and of itself until I sell it thus completing the transaction.
Yes, the market and all of its constituent shares can go up and down in unison but the value going up and down is on paper only. Once I sell the share then I can determine whether I have won or lost on that stock and if I can win enough of those individual stock transactions then my portfolio will increase.
You still haven't explained how a gain in the market is not offset by a loss in the market and that is the crux of our disagreement. Where did my $5 gain come from?
That's simple, if one person buys a share of stock for $15 and sells it later to another for $20 the $5 came from the other person. That person set the value and had the option to buy it or not. Unless he stole the money that $5 over and above what the original owner paid came from the labor of the second person. He paid a price he saw fit so nobody lost anything, if he sells it later for he'll lose the difference.
MikeA: The market is an investment market, not a quantity one. Even the commodities markets(like the oil market) are on projected future value, not the present value of the actual commodity. I have explained it to you every way I know how to explain it. Each stock is an individual matter; they don't relate to each other in terms of value. The overall value of the market reflects, roughly, the value of the overall economy, but any individual stock may increase or decrease in value independently of the performance of the company who originally sold the stock. The market is independent of the businesses in that way. If all stocks go up, they do not do so in unison, as you stated; they are all individually responding to activity in the market. As I said before, it is possible but statistically unlikely. I say again, the $5 you made came because more money was offered for that stock than was available the day before. There are trends, but no individual move is predictable beforehand, unless you have insider information, and that isn't always accurate, either. The value of anything in this system is entirely dependent on what someone is willing to pay for it at the moment of sale. It's all on paper until you buy or sell. It is transactionally determined, and that is the only factor in stock prices. No stock has any intrinsic value.
bullwinkle: Not true. The $5 came from an increase in the perceived value of that stock that day. More people wanted to buy the stock than wanted to sell it that day. No labor is involved in this transaction. The stock values are strictly transactionally determined; nothing else is involved. The stock market has its own reality.
MikeA,
To use your example, the person who buys your single share of stock for $20 (market specialists aside) thinks that the individual share of stock that you are selling to him is worth $20. He is unaware of what you paid for that share. For all he knows, you could have bought it last month for $15 or five years ago for $1. The price you paid is not part of the calculation. Nor is your reason for selling. You could be tryng to raise cash for other purposes. You could be selling because you have another opportunity elsewhere. It could be for tax purposes. Or you could be sellling out of a retirement account because government regulations on such accounts require the sale. The buyer cares about neither your reason for selling nor the price that you paid.
And just as your gain of $5 wasn't realized until you actually sold the share, he is no better or worse off with the purchase... until, of course, he sells the share himself and realizes any gain or loss on that transaction.
MikeA:
Actually I think they have (companies generate wealth), and I think your response was along the lines of "I refuse to believe that".
Companies sell public shares ("stocks") so that they can turn around and invest in their company... over time this makes the company, and shares of that company, more valuable ("wealth is created"). On average, they increase in value about 10-12% per year.
In the real world there are very few long-term zero-sum games. From a physics standpoint, "zero-sum games" are only possible in a strictly linear system. Since the stock market is non-linear (as is any physical system with feedback), the zero-sum game is strictly impossible, given a sufficiently long transaction period.
Your scenario may actually hold if one person buys a stock in the morning, then sells it in the evening. If he waits 10 years before selling it, then on average both parties will make money... especially if they're smart enough to diversify their holdings.
This isn't exactly a new scenario. It's being going on since publically owned companies (roughly the 14th century, I believe).
MikeA,
If it helps any, try substituting a house for that share of stock. Leave out the financing (pay cash) and the situation, while simpler, is virtually the same. Your profit comes when you sell the house, but the person who buys it from you has lost nothing. He has merely transferred some of his wealth/value from his bank account to you in exchange for the house which is valued at whatever price HE paid for it.
Your gain does not equal his loss.
Bat One says
And just as your gain of $5 wasn't realized until you actually sold the share, he is no better or worse off with the purchase... until, of course, he sells the share himself and realizes any gain or loss on that transaction.
Exactly...but that doesn't explain why investing is not a zero sum game. If I make $5 buying and selling a stock then that $5 has to come from somewhere.
Bat One...if the buyer keeps the horse until it dies then I can see your point. You can't ride a share though and so to extract the real value from it you must sell it.
MikeAdamson:
It does. From the creation of new wealth.
Wealth gets created all of the time. Compare your home to one of your distant anscestors... you know, the guys with the cave & the open fire pit. Obviously there was something more than a zero sum game to go from that lifestyle to the modern one.
This seems so obvious, I'm having trouble seeing what you don't understand.
MikeA,
Again, the extra $5 comes from the person who bought the stock from you. And because he valued that share of stock at $20, he is now richer and no poorer for having bought it. He merely transferred $20 of his wealth to you in exchange for a $20 share of stock. The value of that single share of stock is determined by the last transaction in which it changed hands. It may be worth more or less to someone else at any particular point in time, but its only true value is what the last purcahser paid to acquire it.
Carrick,
I just can't wait for the seminar on margin accounts.
Here's a fun link to the application of physics to financing. It addresses form a realists perspective why finance (and so much else of life) is not zero sum.
Here are four links to articles that take my side of the argument. Let me reiterate that I know that there is another side, the side you are all taking,and that your argument is widely held...but it is still wrong in my opinion. Skim through each article and read the stuff on zero-sum if you're interested.
Carrick is right when he says that your points have been explained and that what I'm really saying is that I don't buy it. I fail to see any causal link between the performance of the economy and the performance of the stock market other than that which can be chalked up to investor perceptions of each.
Carrick...good article but I think you're missing my point. I am not talking about the economy or about people's wealth...I am talking about the stock market and only the stock market. Shares represent ownership in a business but they hold no intrinsic value in themselves. I can't ride them, I can't live in them, I must sell them to realize value.
While the number of shares outstanding in any market changes due to new issues,cancellations etc. the fact remains that the total number of shares transacted at any single moment can not exceed the number of shares outstanding at that same moment. Some shares will be more popular and thus rise in price and others less so thus declining in price but taken in the aggregate...the buying and selling of shares is limited to the aggregate number of shares issued at any single time. If this makes sense then maybe I can move on to another point.
"I fail to see any causal link between the performance of the economy and the performance of the stock market other than that which can be chalked up to investor perceptions of each. "
MikeA,
May I assume that we have put the question of the $5 sock profit to rest... at least for the time being? Because the question you raise now, about the relation between the stock market and the economy, is on a whole different level. And while I'm perfectl;y willing to discuss it, with you and Carrick, or Robert108, or anyone else, it will have to wait til tomorrow.
MikeAdamson:
Stocks are holdings of a fraction of the value of a company. As the economy grows, the values of the companies in that economy grow. Hence the value of the stocks---the individual holdings in those companies--- also grows.There's the connection. I don't see how any amount of philosophical musing can eradicate it, either.
Nor can the point I made: Namely, zero-sum implies conservation, and conservation requires a linear system. That's a mathematical argument that's immutable under any amount of hand-waving argumentation.
Some people (on the non-zero sum side) have evoked inefficiency, because that's another mechanism for non-zero-sum, but that would not explain an increase in wealth over time.
An increase in wealth occurs because there is a feed-back loop between investment and the resulting value of the company.
As for your links:
William Sharpe is not arguing for zero-sum economics. He is arguing in favor of passive managment over active management, whether correctly or not is irrelevant to the current discussion. Clearly he accepts that the market increases in value over time.
The link to Charles Ellis has nothing to say about zero-sum economics. He merely makes the point that index funds--which spread risk over multiple companies---are more predictable in their growth than purchases of individual stocks. See Warren Buffet for a counter to his arguments (the "knowledgable" investor), but this is entirely orthogonal to our discussion.
The third link actual is about trading of securities being a zero-sum game. It contains a lot of descriptive language about skilled versus unskilled traders, but contains zero facts demonstrating the zero-sum nature of the market. Indeed, his main thesis---skilled traders get their profit from unskilled traders---does not require a zero sum game!
If you are just trying to tell us that unskilled traders can lose their investment... well, duh! That doesn't prevent the market in the long term from being non-zero sum. Obviously some people lose money in the short run. That's why they say, if you invest in the market, count on leaving your funds there for at least 10 years.
Link four--devoid of any facts demonstrating that trading is a zero-sum game.
Bottom line, mathematics demonstrates that the market cannot be truely zero-sum. (Again, in the long term, you have to wait long enough for the money to circulate to get a feedback. Short-term it could be linear and therefore zero-sum.) No amount of rhetoric can change that fact.
r108 says
If you want to understand and use the stock market, you have to recognize what it is.
Yup. I am quite comfortable with my understanding of the stock market although there's always something new to learn about anything.
MikeA:
Why would you say they have "no value"? That's crazy talk. The company's obviously worth money, you own a percentage of the company, so your share is worth money.
You have to sell it to turn it into something convertable, but that is a completely different statement that "they have no intrinsic value" in themselves. Of course they have intrinsic value, otherwise nobody would buy them from you.
People buy stocks because they think they will be worth more in the future. People sell stocks because they think they will be worth less, or that the increase will be less than some other investment. Even though you can express a total number of shares in the market, their worth is a matter of the relationship between supply and demand at any particular moment.
Carrick: "no intrinsic value" means that they are only worth what the market says they are. If the company goes out of business, they are worthless, except for antique value in a collector market. That is also a matter of supply and demand.
Carrick
William Sharpe is not arguing for zero-sum economics.
Nor am I. I freely acknowledge that wealth exists and that it tends to grow over time. That said, the stock market is not the economy or vice versa.
I'll even grant that the nominal aggregate value of the stock market increases over time but this is due to the influx of new money into the market and not because the stock market has created "value" per se.
I sense your frustration with my position and believe me that I'm just as frustrated with your's. An economy can grow and the companies functioning in that economy can grow and the companies are generating more wealth if the economy is growing...I accept this. The economy grows and individuals become wealthier and the stock market goes up. When the economy slows the stock market slows and even declines...I accept this. You're missing the intermediate step...the stock market goes up because the participants believe that the shares are worth more and goes down because the participants believe that the shares are worth less but there is no automatic link betweeen the economy and the market.
The reason that the stock market has gone up over time is because the economy has created more wealth, a portion of which is directed into the stock market. The market itself doesn't create the wealth, it attracts the wealth and distributes it amongst the market participants.
r108 says
Even though you can express a total number of shares in the market, their worth is a matter of the relationship between supply and demand at any particular moment.
Now we're getting somewhere. What you say is true for individual securities but not for the market as an aggregate. The value of Exxon will vary based on supply and demand but the value of the aggregate market increases only when more wealth is injected into the stock market. This is why the market goes up when the economy grows...the economy is creating more wealth and thus more resources are directed to the market. All of this says nothing about the internal workings of the market however...the market isn't creating value just like the poker game doesn't create value. The market is a distribution mechanism.
MikeAdamson:
I was waiting for this to show up. Really.
I think this statement is the crux of the matter, and gets into some pretty cool cognitive psychology. See The Wisdom of Crowds by James Suroweicki for a nie summary of the "state of the art" on this". The link is not automatic, but it nevertheless exists.
An individual makes a judgement about the value of a company (that is perhaps a better choice of words than "believes"). The average of the judgment of a group of individuals is approximately equal to the true value of that company based upon available information including the risks associated with what is not known.
One good analogy is "guess the number of jelly beans in a jar". If you take any single guess, you will get wildly varying answers, but when you average them, you get a very accurate count.
MikeA:
By this definition, even a dollar has no value, since "it represents something else but doesn't have value in itself....except as wallpaper of course".
Which neglects the principle reason for the existence of public shares: The raising of funds by the company to grow the value of that company. To that extent, if no other, the market creates new wealth.
To demonstrate the validity of the rest of your statement, you would have to be able to show that the total value of the market equals the total amount of money invested into the market. Can you do this? It is a factual statement that should be provably true or false. If it is false, then clearly the market (even in that limited context) is not zero sum.
I would wager that the increase in wealth of e.g. the US stock market outpaces the amount invested in the market, due precisely because of the relationship between the shares in and actual value of a company.
Robert108:
I think this is true, but it skips the question of whether the market is rational. Clearly I am arguing that it is (on average at least). If the market were completely irrational (ie shares were not based at all upon the actual value of the company), I suspect you would get a random walk overtime in the value of the shares.
No doubt this explains some of the short term fluctuations of the value of a particular stock, but does not explain the longer, much smoother trends, which I believe are based upon an aggregate rational assessment of the value of the copmany in question.
R108:
Yeah, I knew that.
But the value obtained from the IPO is generally used to increase the value of the company. If there is a rational relationship between the stock value and the overall value of the company (I hold that on average there is), then this investment also increases the network of the shares of that company over time.
Carrick: Right. The "rational" part of the market is the people who hold stock; those that trade speculatively cause most of the radical and momentary fluctuations. All shares are not traded every day. The short-termers put their energy into the immediate supply/demand relationship, but the long-termers are interested in the overall performance of the company, and to some extent, the overall performance of the market over time.
You are also right about the use of the IPO; since a great many companies use the capital to their advantage, there is usually value created, but it's not guaranteed simply by the act of acquiring capital. One quibble: the IPO increases the value of the company temporarily; the long term increase is due to the effectiveness of the capitalization. Check out the Netscape IPO story sometime.
Robert108, My weasel words were "on average" and "generally". But perfectly said.
An analogy is the homeowner who takes out an equity loan. Some of them squander it on things like a new car, others add new value to their home.
Ahem...you will be pleased to know that I no longer believe stock investing to be a zero sum game. I may provide some detail later but I did want to get my correction on the record.
You're still wrong about everything else of course. ;)