Who Killed Off This Important Driver of Stock Growth?

Dear Early Investor,

“I fired myself,” says Eric Cinnamond.

Eric ran a portfolio of small stocks. He closed his $400 million fund last year. He says that he “couldn’t find anything to buy.”

Things have to be pretty bad for a mutual fund manager to voluntarily call it quits.

So what was spooking this guy?

I came across his story in this past weekend’s Wall Street Journal and had to find out.

I read the article. It was by Jason Zweig, one of the Journal’s most widely read columnists.

Too Few Stocks

I’m glad I did.

Turns out that Zweig shares one of my biggest concerns about investing.

The problem, he says, is that too much money is chasing too few stocks.

“It could lead some fund managers to buy indiscriminately, regardless of value,” he warns.

Zweig blames the shrinking number of public companies. He cites plenty of numbers to prove his case.

While there were 7,355 U.S. stocks in 1997, he says, there are now fewer than 3,600. (His numbers come from the Center for Research in Security Prices at the University of Chicago’s Booth School of Business.)

If this sounds familiar, it’s because I’ve been on a mission these past few months to bring this issue to your attention. (See this recent article, for example.)

In fact, I’ve recently published similar numbers: from 7,500 down to 4,100. More on this in a moment.

This chart shows how much of a hit micro and small stocks have taken…

The tiny public microcap population has been decimated, going from nearly 4,000 to just under 1,900. Lubos Pastor, a finance professor at the University of Chicago, says, “That number is down to less than 1,000 today.”

Why should we care?

The ramifications couldn’t be more serious, says Zweig.

“Historical outperformance… may have been driven largely by the tiniest companies – exactly those that have disappeared from the market in droves.” (Note that I italicized “may,” not Zweig. There’s too much evidence out there proving that historical upswings are largely driven by very small companies.  A financial journalist of Zweig’s repute shouldn’t be pulling his punches like that.)

Zweig calls them tiny companies. I call them startups.

At one time, startups went public early and without a second thought. It was considered a good thing… a huge milestone to be celebrated.

The IPO’s Fast Fade

At some point, things changed… and startups threw out the old playbook and adopted a new one.

No longer do these small companies brimming with promise and potential growth automatically go public so early. In fact, it’s becoming rarer and rarer.

Even if there were some light at the end of the tunnel, this would be serious. But there’s no light to be seen. The numbers, Zweig says, show no signs of recovering.

I agree. What we’re experiencing is NOT seasonal or cyclical or temporary. It’s a permanent shift in the investing ecosystem.

What Happened?

Zweig points to “the flood of venture capital funding” keeping companies from going public.

But the public markets are on a tear, having more than tripled in the past eight years. If there ever was a time for these companies to join the public stock exchanges, it would be now.

Founders would turn into multimillionaires overnight. They’d be able to reward their loyal early employees. Their early investors would finally be able to cash out their shares.

Something else is clearly going on. Zweig takes a stab at it, mentioning private equity behavior and red tape.

But that doesn’t explain why IPOs are plunging… why they numbered only 111 last year (compared to 624 in 1996).

Zweig starts a critical conversation here, but he fails to finish it. How could he not mention the role of the government, for example?

The “melting away” of thousands of companies doesn’t happen by accident or out of the blue. Something happened… something that set off an unfortunate chain of events that’s led to where we are today… with shrinking markets and the historical driver of stock market growth missing in action.

Crisis? That’s a word one shouldn’t throw around haphazardly.

Listen, I’ve thought long and hard about whether this could end well. It won’t. I can see only one solution… just one way for the investing public to avoid the pain of a market sell-off I believe is lurking right around the corner.

To understand the solution, you need to educate yourself on the origins of this crisis-in-the-making. I go into all the gritty details in my new report.

It completes the story that Zweig was brave enough to bring to light this past weekend. I don’t blame him for his carefully worded warning that “Investing… might be less profitable in the future than… in the past.”

Wall Street Journal writers can’t be shouting from the rooftops to flee the markets before it’s too late. That’s far too alarmist for a mainstream publication.

And the good news is… it’s not too late. My report is free. It tells you what you need to know and what you need to do. There’s still time to act.

Invest early and well,

Andy Gordon
Founder, Early Investing