Stock markets have been one of the primary asset classes that investors hold, across the board, from private investors, to the best performing mutual funds, savings vehicles to shareholder employees. Looked at in the long term, the stock markets have outperformed most other asset classes - including the best CD money market rates - so such an inclination is not surprising. But is the case for investing in stocks overblown? Are we, in fact, about to enter a new investment regime, where the frothiness of the stock market is a thing of the past?

Aggressive accountancy

One of the things that has characterized the corporate sector over the last 3 decades, since the flood gates to financial engineering were opened, has been how balance sheet manipulation has become a primary industry. Corporate accountancy has always involved a large element of creativity, as companies have sought ways to be more tax efficient; that is to say, to avoid paying tax. But the scope for doing so remained relatively limited until the advent of a sophisticated derivatives market, courtesy of the whiz kids of investment banking.

Since then, ‘aggressive accountancy’ has become one of the primary concerns of the management of corporations, with the ultimate objective of enriching the top echelon, at the expense of those investing in stock. This has been achieved by presenting corporate accounts in such a light that share prices can be manipulated up or down - a classic problem of those who invest having imperfect information, allowing those able to generate the information, to take ruthless advantage.

For instance, by use of ‘off the balance sheet’ derivatives, cash flows can be hidden from what is presented to those investing in stock markets, and so the stock price can be temporarily depressed. The objective of the board here would be to encourage the approach of aggressive takeovers, from which their strategically placed employee shareholdings can benefit enormously, as stock prices rocket once again.

Redressing the balance

Is this fraud? Shouldn’t the SEC have come down hard on the corporations misrepresenting themselves in such a deliberate fashion? Those investing in stocks have certainly been duped on many an occasion. Unfortunately the SEC enforcement against white collar crime has, for far too long, been feeble at best. But after repeated corporate financial scandals, from Adelphia to Enron, politicians had enough of being seen bailing out the corporations at the tax payer’s expense, and appeared to enact tougher regulation, thus the Sarbanes-Oxley Act in 2002.

But that didn’t prevent the near meltdown of the credit system in the global financial crisis. Massive tranches of tax payer money were thrown to Wall Street to prevent its collapse. After the fact, you would think that is would lead to the deployment of the toughest regulatory regime seen in a generation – and maybe a change in the way the stock market works, but that is not the case. The long stock market frenzy of greed and overvaluation continues on unabated.  Because of these factors, the best way to invest money is not by investing in stocks.