Who Killed Off This Important Driver of Stock Growth?

“I fired myself,” said Eric Cinnamond.

Eric ran a portfolio of small stocks. He closed his $400 million fund last year. He said 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 The Wall Street Journal and had to find out.

It was written by Jason Zweig, one of the Journal‘s most widely read columnists.

Too Few Stocks

Turns out that Zweig shares one of my biggest concerns.

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 also discussed this issue. (See this article, for example.)

I’ve also 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. Zweig agrees with me. He says that “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

Things changed eventually… and startups threw out the old playbook and adopted a new one.

No longer do these potential fast growers – brimming with promise – 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.

He’s right.

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 have 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.

Why wouldn’t founders jump into public markets? It would turn them into multimillionaires virtually overnight. They’d be able to reward their loyal early employees. And 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). This year also saw a low number of IPOs (no official numbers published yet, though).

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.

Is this a “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. The pain of a market sell-off is approaching.

Zweig was brave enough to bring this issue to light. I don’t blame him for his overly cautious 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. Investing in startups is one way around this problem. So is investing in cryptocurrencies.

Good investing,

Andy Gordon

Co-Founder, Early Investing