Gamestop, Robinhood, meme-stocks, gamification. These terms are associated with just the most recent iteration of the never-ending discussion about whether or not short-term ‘traders’ (hereafter ‘speculators’) are a ‘good’ or a ‘bad’ thing.
Analysis in established markets founders on an intractable problem, the lack of a counterfactual. China however may provide a useful case for study.
Until 2010 China banned all margin funded stock purchase and only from that time selectively introduced it in a series of waves. This test-bed has allowed Jun Chen from the University of California, San Diego to perform a real world before and after analysis.
Her work supports notions about some negative effects speculators are associated with. In particular, in her study:
- Stocks that opened up to speculators had higher turnover than those that didn’t. They also experienced price rises after the speculators were allowed in; BUT..
- This led to management earnings manipulation (to keep the new constituents engaged). It also lead to a very significant reduction of investment by those firms; and..
- This combination of earnings manipulation and reduced investment had a cumulative (negative, natch) effect on firm valuation that began to show up around a year after speculators were allowed in.
Whilst noting obvious differences between the structure of China’s markets (mainly, the much higher component of retail investors) and developed markets the conclusions seem to have general application.
Sufficiently so Ms. Chen believes that “[Her] results give support to a worldwide policy change that aims for a longer investment horizon as well as a tightening of the leverage constraint in both China and the United States.” Good luck with that.
My two pennyworth; it’ll only be after the next major crash you hear more on this. Ms. Chen is optimistic if she believes the need to mend this metaphoric hole-in-the-market-structure-roof will be addressed during the (mostly) clement weather the U.S. stock market (and others) continues to bask in.
The full paper can be accessed via this link Do Speculators Cause Managerial Myopia?
Happy Sunday.