This is how the price of shares is really decided

Satyajit Das in The Independent



Equity investors – who have enjoyed strong gains over the past eight years – are unlikely to question the merits of stocks as an investment. US stock markets have tripled in price since 2009. In nominal terms the Dow Jones Index is up 70 per cent from its peak in January 2000. But 17 years later it is up only 19 per cent in real (inflation-adjusted) terms.

Investors rarely scrutinise the driver of equity returns. In reality stock markets have changed significantly over recent decades, driven by artificial factors that result in manipulated and unsustainable values.

The traditional functions of the stock market include facilitating capital-raisings for investment projects, allowing savers to invest and providing existing investors with the ability to liquidate their investments when circumstances require. Unfortunately, a number of factors now undermine these functions.

First, equity markets have increasingly decoupled from the real economy. Equity prices now do not correlate to fundamental economic factors, such as nominal gross domestic product or economic growth, or, sometimes, earnings.

Second, equity markets have become instruments of economic policy, as policymakers try to increase asset values to generate higher consumption driven by the “wealth effect” – increased spending resulting from a sense of financial security. Monetary measures, such as zero-interest-rate policy and quantitative easing, distort equity prices. Dividend yields that are higher than bond interest rates now drive valuations. Future corporate earnings are discounted at artificially low rates.

Third, the increased role of HFT (high frequency trading) has changed equity markets. HFT constitutes up to 70 per cent of trading volume in some markets. The average holding period of HFT trading is around 10 seconds. The investment horizon of portfolio investors has also shortened. In 1940 the average investment period was seven years. In the 1960s it was five years. In the 1980s it fell to two years. Today it is around seven months. The shift from investing for the long run has fundamentally changed the nature of equities, with momentum trading a larger factor.

Fourth, the increasing effect of HFT has increased volatility and the risk of large short-term price changes, such as that caused by the 7 October “flash crash”, discouraging some investors.
Fifth, financialisation may facilitate market manipulation, with the corrosive impact of insider-trading and market abuse eroding investor confidence.
US federal investigators found a spider’s web of insider-trading exploited by a small group of funds that benefited twice: from both trading profits and artificially enhanced returns. These, in turn, generated more investments and higher management fees. The investigations revealed expert network firms, which provided “independent investment research”. Redefining the concept of expertise, these firms seemed to specialise in matching insiders with traders hungry for privileged information, routinely allowing access to sensitive information on sales forecasts and earnings.

Regulators suggested that the practice was so widespread as to verge on a corrupt business model. Reminiscent of the late 1980s investigations into Drexel Burnham Lambert, Ivan Boesky and Michael Milken, the clutch of prosecutions has created an impression that a small golden circle of traders have an information edge, disadvantaging other, especially smaller, investors.

Finally, alternative sources of risk capital, the high cost of a stock market listing, particularly increasing compliance costs, increased public disclosure and scrutiny of activities including management remuneration as well as a shift to different forms of business ownership, such as private equity, have changed the nature of equity market. New capital raisings are increasingly viewed with scepticism as private investors or insiders seek to realise accreted gains, subtly changing the function of the market. The problems are evident in both the primary markets (lower numbers of initial public offerings of new shares) and in the secondary markets (reduced market turnover).

The recent Snapchat IPO illustrates the trend. Snap, a young, still unprofitable company, saw its shares soared 44 per cent on its first day of trading, although it fell sharply subsequently. Shareholders providing capital will not be able to control the company, as company insiders have not given common stockholders voting rights, which is inconsistent with conventional corporate governance models. In technology-intensive sectors, for example, entrepreneurs, such as those associated with Snap, now use IPOs to either facilitate exits for venture capitalists and founders, create a currency in the form of listed shares to compensate or finance acquisitions, or raise cash to fund shortfalls between revenue and expenditure.

The declines are symptomatic of the problems of excessive financialisation. Financial instruments, such as shares and their derivatives, are intended as claims on real businesses. Over time, trading in the claims themselves have become more rewarding, leading to a disproportionate increase in the level of financial rather than business activity. Longer term, the identified developments threaten the viability of the stock market as a source of capital for businesses and also as an investment, damaging the real economy.

World’s largest hedge fund to replace managers with artificial intelligence

Olivia Solon in The Guardian


The world’s largest hedge fund is building a piece of software to automate the day-to-day management of the firm, including hiring, firing and other strategic decision-making.

Bridgewater Associates has a team of software engineers working on the project at the request of billionaire founder Ray Dalio, who wants to ensure the company can run according to his vision even when he’s not there, the Wall Street Journal reported.

“The role of many remaining humans at the firm wouldn’t be to make individual choices but to design the criteria by which the system makes decisions, intervening when something isn’t working,” wrote the Journal, which spoke to five former and current employees.

 

Ray Dalio, president and founder of Bridgewater Associates. Photograph: Bloomberg/Bloomberg via Getty Images

The firm, which manages $160bn, created the team of programmers specializing in analytics and artificial intelligence, dubbed the Systematized Intelligence Lab, in early 2015. The unit is headed up by David Ferrucci, who previously led IBM’s development of Watson, the supercomputer that beat humans at Jeopardy! in 2011.

The company is already highly data-driven, with meetings recorded and staff asked to grade each other throughout the day using a ratings system called “dots”. The Systematized Intelligence Lab has built a tool that incorporates these ratings into “Baseball Cards” that show employees’ strengths and weaknesses. Another app, dubbed The Contract, gets staff to set goals they want to achieve and then tracks how effectively they follow through.

These tools are early applications of PriOS, the over-arching management software that Dalio wants to make three-quarters of all management decisions within five years. The kinds of decisions PriOS could make include finding the right staff for particular job openings and ranking opposing perspectives from multiple team members when there’s a disagreement about how to proceed.

The machine will make the decisions, according to a set of principles laid out by Dalio about the company vision.

“It’s ambitious, but it’s not unreasonable,” said Devin Fidler, research director at the Institute For The Future, who has built a prototype management system called iCEO. “A lot of management is basically information work, the sort of thing that software can get very good at.”

Automated decision-making is appealing to businesses as it can save time and eliminate human emotional volatility.

“People have a bad day and it then colors their perception of the world and they make different decisions. In a hedge fund that’s a big deal,” he added.

Will people happily accept orders from a robotic manager? Fidler isn’t so sure. “People tend not to accept a message delivered by a machine,” he said, pointing to the need for a human interface.

“In companies that are really good at data analytics very often the decision is made by a statistical algorithm but the decision is conveyed by somebody who can put it in an emotional context,” he explained.

Futurist Zoltan Istvan, founder of the Transhumanist party, disagrees. “People will follow the will and statistical might of machines,” he said, pointing out that people already outsource way-finding to GPS or the flying of planes to autopilot.

However, the period in which people will need to interact with a robot manager will be brief.

“Soon there just won’t be any reason to keep us around,” Istvan said. “Sure, humans can fix problems, but machines in a few years time will be able to fix those problems even better.

“Bankers will become dinosaurs.”

It’s not just the banking sector that will be affected. According to a report by Accenture, artificial intelligence will free people from the drudgery of administrative tasks in many industries. The company surveyed 1,770 managers across 14 countries to find out how artificial intelligence would impact their jobs.

'This is awful': robot can keep children occupied for hours without supervision



“AI will ultimately prove to be cheaper, more efficient, and potentially more impartial in its actions than human beings,” said the authors writing up the results of the survey in Harvard Business Review.

However, they didn’t think there was too much cause for concern. “It just means that their jobs will change to focus on things only humans can do.”

The authors say that machines would be better at administrative tasks like writing earnings reports and tracking schedules and resources while humans would be better at developing messages to inspire the workforce and drafting strategy.

Fidler disagrees. “There’s no reason to believe that a lot of what we think of as strategic work or even creative work can’t be substantially overtaken by software.”

However, he said, that software will need some direction. “It needs human decision making to set objectives.”
Bridgewater Associates did not respond to a request for comment.