Sometimes we feel as though there are two distinct financial worlds: the one that reflects the prospects of the economy, and the other, the stock market. Sometimes we feel this way as we see upswings when disappointing employment statistics or real estate data is released, or when rating agency downgrades long after the initial catalyst cause markets to decline feigning surprise. Word among the cognoscenti is that this is a “traders’ market,” with very few actual investors in the mix. The distinction is, on one level, of fundamental versus technical value drivers, or on another level between long term fund management and algorithmic programs.
Another way of saying the same thing may be that the public market is fueled by the low capital cost of large financial institutions and the machine trading systems that such organizations sponsor. If this is the case, then, in addition to a disconnect between economic catalysts and their result on stock charts, there may also be a divergence of a different sort: that between corporate types. In this respect, there would now also be two worlds: the one that is private, independent, and whose prospects correlate with economic prospects very purely, and the other, with access to trading desks.
One illustration of this potential chasm can be seen in the plight of venture capital and other private equity segments. In these, shareholders with two traditional alternatives to achieve liquidity – the IPO and the M&A exit, or the IPO followed by eventual M&A – appear to be moving decisively in the direction of M&A alone. While it is true that a more correct interpretation would be that the IPO alternative is moving decisively away from these investment funds, the case still remains that small and mid-sized corporate targets are increasingly in pursuit of strategic rather than financial public buyers. And the acquirer is typically going to be a public entity with a market cap in the billions, tens of billions, or even hundreds of billions. These buyers are the fortunates that, in the parlance of the previous paragraph, have access to the trading desk. And as assets flow to their most attractively priced capital sources, the large-caps in the environment described become consolidators for reasons not necessarily related to economic fundamentals.There has always been a distinction between the capital-rich and the capital-seeking in economics, and the two have always gravitated to one another as the circumstances have presented themselves. But, once again, there would now be an important difference if this distinction is largely the result of size, market float, market cap, and, in short, stock tradability… rather than economic prospects more purely speaking. Ultimately, this scenario could give rise to a consolidation wave that will reduce the small and independent market and increase the large-caps even further. With the Russell 2000 index recently outperforming the S&P 500, the explanation appears to be one of takeover speculation. So we may already be starting to see the process unfold.
Disclosure: No positions.