Allocation of capital

Wookster

We've had a fair bit on this forum about inefficient allocation of capital to the public sector but not much about funds being diverted to stock market speculation rather than being invested directly in productive entities.

Perhaps a tax on pure speculation might help to start changing this. The band on shorting will probably help as well.

HAMISH_MCTAVISH

HAMISH_MCTAVISH wrote: »

Call me old fashioned, but shares should be a buy and hold investment, dependent on dividends to yield a profit.

"Investing" in a company that has already floated (usually) does no good for that company, it already accessed the funds from the float. So it's just speculation, paying off a previous speculator. And the short term managerial mentality of always pandering to the share price with the next set of quarterly results is a destructive force in business, IMO.

Equities "investment" has become equities speculation.

Short selling is the most visible facet of a system that has become rotten to the core.

It should be banned.

...........

Wookster

Hamish, how do you marry that with your comments on property? Or is property a sure thing rather than speculation?

Generali

There already is a tax on profits from speculation: capital gains tax.

Not all shorting is speculative, far from it. Plenty of hedge funds hedge their equity exposure by shorting the market as a whole to reduce risk. The idea is that if you pick stocks well, they will do relatively better than the market as a whole. If you then short the market and are long the individual shares that you think will do well you get the upside generated by your awesomeness without the downside generated by the market as a whole falling.

It also used to be very common for gold miners to be short gold in the market so their company was a pure play on the operational side of the business rather than a bet, in part, on future gold prices. Again the idea was to reduce risk.

I don't see the problem with short selling in general TBH. You still need to have a buyer on the other side of the trade and it is most definitely not a one way bet as shorts in VW found out to their cost.

Loughton_Monkey

I wonder how you would distinguish between 'investment' and 'speculation'?

So I buy some BSkyB because I think there's a lot more sport coming up and people are subscribing, and I put them in my portfolio and move on. That's investing. Then I get wind of Murdoch's problems and get jittery. So I sell a month later because I'm not a risk-taker. Is that speculation? You believe too many people are over-reacting so you buy my shares at 10:00 a.m. for 700p and at 3:00 p.m. they have risen to 715.5p so you sell. That's definitely speculation.

In any free market of shares, you will always find a spectrum of 'buyers'. At one extreme the Warren Buffets who buy for all the 'good reasons you suggest, Hamish. At the other end, you have the 'scalp trader' investing in CFD's (or spread betting) who is literally holding for 25 minutes in order to make a 0.2% profit. One way of stopping this might be to ban derivatives like CFD's and force people to buy 'proper' shares - with stamp duty etc. This clears out the scalp traders and day traders, but actually these [handful of] people don't 'move' the price at all. They are so insignificant. It's the Institutional investors buying and selling huge blocks of [physical] shares who do that.

Personally, I am very nervous of derivatives in most forms. Even 'shorting', in effect, could be considered a 'derivative' since at the time of shorting, no physical change of share ownership is involved. I am of the view that trading in derivatives should not be banned, but reclassified as 'gambling', and furthermore, Financial Institutions like banks should be banned from 'gambling'. This would tend to seperate the Investors from the Speculators, the former dealing with banks [stockbrokers], and the latter dealing with Ladbrokes [or similar].

You would get problems, though, in the currency markets. Pure speculation in currency rates is essential to 'oil' the wheels of international commerce. It is vital that a large foreign contract being paid for in $US should be backed up by the ability of the British contractor to 'lock in' the value of that contract in £UK for a small premium. He can, in effect, only do that properly with a derivative (future) of some form.

As a bit of cerebral exercise, it might be fun to consider your house. Consider it as an asset, for which you own 100% of the shares. Imagine Goldman Sachs creating some sort of 'derivative' in the value of your house and floating this on the market. So 10,000 people in your neighbourhood are actively trading in £100 'units' of your house value. Today it is 'worth' £250,000. Someone notices a delivery of a concrete mixer.... speculation of a new improvement (extension) going up. Price zooms to £265,000. Local Estate Agent issues report that bigger houses are eagerly required. Your price goes up even more, to £270,000. Later on, the rumour hits the street that actually you are not extending, but have subsidence. Price crashes to £186,000........

The mind boggles. Geneer would be physically wetting himself all day - even more so than now!

StevieJ

Generali wrote: »

I don't see the problem with short selling in general TBH. You still need to have a buyer on the other side of the trade and it is most definitely not a one way bet as shorts in VW found out to their cost.

I don't have a problem either as long as come down hard on the rumour mongers, like they do insider dealers.

Generali

@LM short selling does involve a transfer of ownership it's just 'naked shorting' that doesn't (naked shorting is when you sell shares without borrowing them so you don't deliver what you sold). Naked shorting is illegal in the US and rightly so IMO.

It would be pretty easy to enforce too via non-delivery fines. Don't ban naked shorting, just make it expensive. It would make for a more orderly market too.

StevieJ wrote: »

I don't have a problem either as long as come down hard on the rumour mongers, like they do insider dealers.

It's already illegal to do this. Of course proving it is the hard part.

Loughton_Monkey

Generali wrote: »

@LM short selling does involve a transfer of ownership it's just 'naked shorting' that doesn't ..

.. forgive my pedantry, but I did think this one through before writing it. It does not involve transfer of ownership. It involves 'borrowing' which is a different thing. That's why I 'consider' it to be a derivative. The share itself has legal ownership. Any form of borrowing on it involves 'promises' and is hence not physically tangible.

I view it in a similar way to your mortgage. The bank lends only against the physical security of your house. The bank can even sell your mortgage, but it doesn't at this point own your house - just the physical ability to do so under certain conditions. Those conditions are reasonably secure 'contractually', but contain additional risk such as the owner burning it down [uninsured], or simply trashing it with a JCB.

michaels

More funds in the stock market = higher share prices = cheaper capital for companies = more investment. the reason the funds are invested (long term, speculation) is irrelevant.

Lets look at the BSkyB example - buy the shares at 700p because you estimate that the companies management and prospects (and thus future dividends and share price appreciation) make the 700p price below your best estimate of fair value. Later the price has risen and it is now above your estimate of correct value so the rational thing to do is to sell as your best guess is that the share return will under perform what you could get elsewhere. Thi sis nothing to do with short-termism or speculation, it is just rational allocation of capital.

HAMISH_MCTAVISH

Wookster wrote: »

Hamish, how do you marry that with your comments on property?

Which comments on property?

I've repeatedly said property is, and should be, a long term investment and that market instability is a bad thing.

That yields on property should be the main consideration for any BTL investor, and capital gains (whilst probably inevitable due to the long term shortage that shows no sign of abating) are secondary.

I've also repeatedly called for more houses to be built, increasing supply, and ultimately reducing cost over the long term. Although I doubt there is any chance of meeting the need for housing, we should still try much harder, as without significantly more building the next boom/bust cycle will be huge.

Generali

Loughton_Monkey wrote: »

.. forgive my pedantry, but I did think this one through before writing it. It does not involve transfer of ownership. It involves 'borrowing' which is a different thing. That's why I 'consider' it to be a derivative. The share itself has legal ownership. Any form of borrowing on it involves 'promises' and is hence not physically tangible.

I take your point but from the buyers pov the share is bought and they have full beneficial ownership of that share. Whether the seller bought or borrowed it is immaterial; nobody else has a claim over that share.

The problem lies with the borrower who has to return the stock on demand.

<pedant mode>The price of the share that the buyer bought is set by price discovery in the market place. The term 'derivative' is used because the price of it is derived from that of the underlying asset rather than being that of the underlying asset. The price of the share is the same whether it was bought or borrowed to be sold, it isn't derived. </pedant mode>