Stock Markets

This essay offers a broad description of the United States (US) and international stock markets, the interplay and globalization of these financial spheres, and ultimately the relationship between the US economy and the stock market. To develop a better understanding of the complexities of the market, the article weaves into context events of the famous Stock Market Crash and the resulting regulatory safeguards in place today. The essay is easily understood by those new to the world of financial markets and provides a springboard for exploration into the complex and sometimes risky world of financial markets.

Keywords: Great Depression; Growth Companies; Investment Company/Firm; Investment vehicle; NASDAQ; New York Stock Exchange; Primary Market; Recession; Secondary Market; Securities; Securities and Exchange Commission (SEC); Stock Exchange; Stock Market Crash; Stock Market; Globalization

Finance > Stock Markets

Overview

For the reader, a 30,000 foot view of the financial investment field for corporations, investors, brokers, and managers – the stock market - follows. Scores of businesses start small, as one or two person enterprises; with continued growth the successful develop into a partnership, and in due course a full-fledged corporation is born. Corporations need short-term money to maintain accessible inventory and capital; they usually accomplish this by borrowing directly from banks. When a corporation needs longer-term financing, funds can be obtained by selling off portions of the business in the form of common or preferred stocks. These same stocks attract investors who often trust their monies to large securities firms or dealers who specialize in investing. The expectation is that the professionals working for the firm will handle the investor's money well, with many years of expertise guiding their decisions. The Stock Market is the trading field for exchanges worldwide.

Applications

Defining "The Markets"

The stock market takes two forms: A virtual (electronic) marketplace and the other a true, physical marketplace. The market, put simply, is the venue that facilitates the selling and trading of securities (primarily bonds and common stock); the employees are known as 'stockbrokers.' The brick and mortar stock exchange on Wall Street, USA, brings to mind images of tumultuous crowds of traders and investors shouting orders to sell or buy - the classic picture of rapid decision-making based on indicators, gut instinct, or computer-directed trading recommendations. The US market consists of stock exchanges, the vehicles by which securities are bought and sold. The size of the US stock market, in today's dollars, is $51 trillion. The short list of what comprises "the stock market" includes stock exchanges, commodities, bonds and other exchanges, a few of which are listed below:

  • The New York Stock Exchange
  • The Dow Jones Industrial Average
  • NASDAQ (National Association of Securities Dealers Automated Quotations system)
  • OTCBB (Over the Counter Bulletin Board)
  • Pink Sheets

United States Stock Exchanges

The New York Stock Exchange (NYSE), nicknamed "The Big Board," is the oldest and largest dollar volume bidding market for stocks in the United States. The NYSE, situated on Wall Street, obtained its first publicly traded company in 1792. Public trading of the over 2,700 securities on the NYSE is driven by supply and demand; an economic challenge of changing equilibrium driven by sellers and purchasers in an auction-like environment. In 2008 the NYSE acquired the American Stock Exchange (AMEX), the second largest stock exchange in the United States (Amex members approve buyout, 2008).

  • The Dow Jones Averages are stock market indices that express the U.S. economy in three distinct sectors: Industry, transportation and utilities. The averages are calculated from a compilation of data from thirty companies in these sectors.
  • The NASDAQ is the largest electronic stock-bidding market in the US. There is growing preference for electronic exchanges because this mode increases competition while offering equal access for large and small investors alike. The NASDAQ Composite is a listing of stocks, and their composite values; it represents a tool characterizing its component stocks, all of which have some common characteristic. For example, component grouping may be those trading on the same exchange market, being participants in the same industry, or having similar market capitalizations (the calculated value of a company). The NASDAQ is considered an indicator of stock performance in technology and growth companies - those whose rate of growth significantly exceeds that of the average in their field.
  • OTCBB stands for the Over the Counter (OTC) Bulletin Board, a structure that provides an electronic quote system for numerous over the counter securities not listed on the national or the NASDAQ exchange. The OTCBB provides brokers with real-time quotes, last-sale prices, and volume information. Anyone who subscribes to the system can use the OTCBB to look up prices or enter quotes. Like the larger, more familiar exchanges, eligibility rules for the OTCBB require SEC registration of current financial reports.
  • Pink Sheet Stocks are over the counter trading securities that are not large enough to be listed on the bigger exchanges. These smaller company stocks are primarily high risk; considered some of the most speculative investments. The Pink Sheets are, quite literally, a daily pink-colored publication of the 'bid and ask' prices of thousands of over-the-counter stocks for companies who are smaller in asset size and have lower share prices.

International Stock Market Exchanges (Non-US)

International stock exchanges, far too numerous to list here, include the London Stock Exchange, the Bourse de Paris, the Tokyo Stock Exchange, and the Hong Kong Stock Exchange. Globalization is pushing stock exchanges around the globe to combine and buy stakes in each other to meet clients’ demands. Today’s investor wants are simple: investors want to trade stocks of companies located anywhere in the world at a fast pace, across various classes of assets, for a cheap price. Globalizing exchange transactions saves costs in this industry since the largest single expense is building the technology to operate trading platforms (Werdigier, 2007).

History & the Regulation of the Stock Market under Pressure

The catastrophic stock market crash of 1929 ended the prosperity of the era and brought upon the United States a disaster never to be forgotten. Reasons for the crash remain uncertain, though the most solid theory speculates that investors rapidly selling their stocks for profit led to unrest and a groundswell of anxious people following suit. The businesses that relied on investors' money began to fail; vast numbers of people lost their jobs as a result. Without jobs, people withdrew money from their checking and savings accounts out of fear for their very survival. The banks simply could not meet the demands for monies, having invested much of the depositors' cash into the spiraling stock market, so many of the financial institutions failed right alongside other weakening companies. The entire economy began a treacherous downward spiral, ultimately leading to the Great Depression. Speculation that the Stock Market Crash of 1929 was caused by a lack of formal rules and regulations led to Franklin Delano Roosevelt's urging of Congress to pass the Securities Act of 1933 and the Securities Exchange Act of 1934. These two legislative acts led to strict regulation of how new stocks were issued and how stocks were to be traded. Today, any company that sells stock (corporations) must register with the Securities and Exchange Commission (SEC), which provides investors with the assurance of a much more stable market.

Fears of Market Crash Assuaged

In October, 1987, apprehension was mounting as stock prices declined precipitously. The market had been doing so well for so long; few were surprised when the decline began. By the time the Dow Jones average had dropped over 500 points on October 19th, panic ensued; the day was dubbed "Black Monday." Yet, a full stock market crash was never realized, a credit to Congress' proactive 1934 legislation. Today, strict barriers to deception are enforced; for example; firms are required to submit proof to the SEC of how much money they have on loan to customers in relation to their cash reserves. Scrutiny of every report submitted assures that firms have enough cash on hand to continue operations for a specified amount of time, thereby protecting the customers' financial well-being.

Other safeguards exist, including "Regulation T," which requires that purchasing of stocks on credit is permitted only when the investor deposits at least 50% of the market value of the stock with the broker (Dalton, 2001). In the 1920's, the market was taught a lesson a little too late by a dangerous precedent that allowed purchase of stocks with a mere few dollars on deposit. Additional legislation brought forth the Glass-Steagall Act of 1930, which provided regulatory controls in defining commercial versus investment banks. The act disallowed financial intermediaries (investment banks) that advise clients on mergers and acquisitions to function as commercial banks (whose main business functions are taking deposits and making loans for commercial or consumer purposes).

"The Glass-Steagall Act was enacted to remedy the speculative abuses that infected commercial banking prior to the collapse of the stock market and the financial panic of 1929-1933. Many banks, especially national banks, not only invested heavily in speculative securities but entered the business of investment banking in the traditional sense of the term by buying original issues for public resale. Apart from the special problems confined to affiliation, three well-defined evils were found to flow from the combination of investment and commercial banking" (Benston, 1990).

Glass-Steagall was repealed in 1999 and there followed a period of acquistions that once again married commercial and investment banks. After the string of bank failures beginning in 2007 and the prolonged and global financial crisis that followed, critics called for a return of Glass-Steagall. Many economists noted that under Glass-Steagall there had been no big-bank failures (Glass-Steagall: Repeal the repeal?, 2013). Opposition by financial institutions, however, remained strong.

Impact of Globalization: October, 1987 & 2007

Globalization has led to real time communication and internet access worldwide; the market continues to grow more and more virtual every day. There are few today unable to participate in the market because of access restraints. Market money virtually transfers from one continent to another with the click of a computer. Because of the high-tech linkages that existed, it was no surprise that the international markets felt panic alongside their US counterpart on Black Monday in 1987. Japanese, British, German and Swiss markets tumbled in synchrony with the U.S. market drop. Reliance on computer-managed stock portfolios did not protect money managers who were counting on the electronic programs to respond safely and appropriately to these kinds of rapid changes. When the electronic system failed, it was clear that no one knew where the stocks were headed. Portfolio managers learned there was no replacement, electronic or otherwise, for experienced human decision-making.

Discourse

The Stock Market's Relation to the US Economy

The stock market fluctuates up and down, sometimes from benign causes; sometimes for more troublesome reasons. Risk-averse investors, particularly the less experienced, are apt to act rashly, selling off stocks for fear of corollary economic downturns. Prudent investors must understand that a direct correlation between market downturns and the economy cannot and should not be assumed. "Wall Street is not Main Street. Its fluctuations may demonstrate economic health and distress, but often does not. It can be reacting to evidence of rapid, broadly shared economic growth -- or the prospect of such growth -- and in those cases, it should elicit a cheer from us all. But it also can be reacting to higher corporate profits that come not from increased productivity or growth but directly out of wages, benefits, higher prices or a variety of cost-saving, corner-cutting measures that don't make the median American's life any better. Sometimes, the market is just reacting to shortsighted business practices that supercharge earnings, but only temporarily -- as in the case of the housing boom. Or it can go up because of simple irrational exuberance that is reversed with the next morning's trading -- or the next year's crash. The market's fluctuations may not say much about the economy, they may not be as simplistically positive or negative as they seem at first glance, and they may not signal durable trends. They must be treated with care. The media, however, don't have a whole lot of time to treat them with care. In an age of 24-hour financial channels and daily business broadsheets, the allure of an easily comprehensible number that comes out every few seconds and can serve as the subject for further commentary is hugely seductive. Increasingly, the stock tickers serve the same purpose in economic reporting that poll numbers serve for political scribes: They provide constant, reportable data that can be used to draw broad conclusions about the subject as a whole -- but at a cost of accuracy, random fluctuations and significant separation from the issue at hand" (Klein, 2007).

Opportunity Present in a Tumultuous Market

For the stout of heart, menacing market downturns present an opportunity to gain, especially as others panic and sell. Impressions from Gene Marcial of Business Week offer sage advice for the investor in August of 2007. "This latest round of panic selling presents steeled investors with a unique buying opportunity. Let's be realistic and get a grip. If I were an investor with ample resources, or a money manager who feels besieged by the market's latest tantrum, I would go shopping -- for stocks. Not just any stock. I would buy the market's top losers on Thursday, Aug.9, when the Dow Jones industrial average plummeted 387 points, or 2.8%, to 13,270.65. And now we have the sub prime mortgage woes. If you buy these loss leaders now, you will see them in the big-winners list next year, if not sooner. My point is the stock market should be seen for what it really is: a market of opportunity. If you take such a perspective, you will never panic, whatever is causing people to rush for the exits. That is the herd mentality at work. Be prepared for the market to exhibit extreme behavior. A market that is plunging is an opportunity to buy the stocks you know are solid. When the market is scoring record highs, as it did earlier this year, take profits to build up a reserve fund" (Marcial, 2007). Proactive financial advisors know that bear markets are inevitable; counseling their investors to diversify mitigates the impact when the market starts to drop, and alleviates some anxiety of their clients.

Capitalizing at the Right Time

The markets have a way of adjusting to fears when exchanges show clear and continued signs of a bear approaching. The reader can find dozens of sources in the literature cautioning against over-anticipation and reactivity to a market downturn. Financial performance uncertainty can cause panic and a flawed belief that the market is following a path to recession. But, anytime there is fear, there are those who capitalize on risk - willing to take advantage and win from others' uncertainty. Advice following the summer of 2007 roller coaster ride from Business Week Online: "Until a trend is clear, expect the market to continue to swing wildly as investors place bets on their fears, real or imagined, of a U.S. recession" (Steverman, 2007).

Jason Kirby, of MacLean’s, recently highlighted a risk-taking company whose objective is to capitalize on the debts of struggling companies. “Stock markets the world over have been in free fall. Four years of optimism have suddenly given way to fear. Finally, things are starting to look up for Toronto money manager Alex Jurshevski. Jurshevski is CEO of Recovery Partners, an investment firm he launched in 2005 to pursue the risky strategy of buying portfolios of underperforming corporate loans from banks in North America and Europe. By snatching up the debt of struggling companies, he aims to take over the businesses, turn their fortunes around, and resell them. It’s a precarious strategy, akin, he says, to safely catching a falling knife, but it’s one that promises huge returns. Jurshevski is part of a relatively small but vital niche of the business world that thrives on the trials and tribulations of other companies” (Kirby, 2007, ¶1).

Housing & Mortgage Loan Struggles

In autumn of 2007, housing market downturns continued to dominate the media, sparking fears in the economy and the nation. Electronic News reported,

“Technology stocks were not at all immune as the U.S. stock market took a plunge upon opening this morning, with fears of a potential crisis in the credit markets spurring steep declines in stock prices worldwide. After the opening bell this morning, the Dow Jones Industrial Average quickly plummeted by more than 212 points to hit 13,057.86 just after 10:30 a.m. ET. At around the same time, the NASDAQ market, on which the majority of tech stocks are traded, fell to 2,503.16--two percent below the previous day’s close and down a whopping 8.1 percent from the index’s status less than a month ago. Financial analysts say that larger effects of the long-struggling housing market are a major cause behind the widespread plummet. ‘What began with rising delinquencies on U.S. home mortgages to risky borrowers months ago has evolved into a world-wide flight from risk by investors,’ according to a Wall Street Journal report. “The ripple effects have… knocked dozens of lenders out of business, battered an already weak housing market and fueled weeks of stock-market turmoil. Marking the severity of the situation, the United States Federal Reserve issued a statement saying that it would provide “reserves as necessary” in an attempt to help stabilize and reassure the volatile market. On Friday, the Fed said it would accept $19 billion, and then another $16 billion, in mortgage backed securities to provide liquidity to the market; earlier, on Thursday, the Fed injected $24 billion in temporary reserves to the U.S. banking system. Similarly, banks around the world, including the European Central Bank and the Bank of Japan, injected funds this week into their own respective stock markets; according to the Associated Press, this week’s events have marked the first time such banks have worked together to add liquidity to the markets since the aftermath of the September 11 attacks in 2001” (Taylor, 2007, ¶1-3).

The crash that began in 2007 did not bottom out until March 9, 2009. The crash was not confined to US stock markets but was repeated in markets around the world during the six months following the initial American crash. Market losses between 2007 and 2008 totaled $21 trillion worldwide (Meric, Lentz, Smeltz, & Meric, 2012). On May 6, 2010, the Dow Jones Industrial Average lost 998 points when high frequency traders, a new phenomenon of the digital age, began a frenzied game of "hot potato," trading stocks downward in reaction to a single large trader's sell order. The market recovered somewhat before closing as it became apparent that something aberrant had occurred (Madhavan, 2012). In August 2011 nervous investors began to move investments from stocks to safer instruments as ratings agencies threatened to downgrade the US credit rating and Europe struggled to cope with failing economies within the Eurozone. In what was termed a "correction," stock markets plunged as they opened around the world. As the political situations were resolved, investors once again looked to stocks for the gains they had come to expect. By November 2013, the Dow Jones Industrial Average had surged above the 16,000 mark.

Conclusion

A complex system, the stock market grows more multifaceted every day. As the world grows flatter; real time transactions across the globe make for quick decisions and even quicker response times. The reader of this essay now understands more clearly the need for thoughtful decision-making; the benefit of rigorous education; and understanding market changes. Reactivity to changes in the market is risky behavior unless preceded by a thorough review and understanding of forces causing the variation. Trends are more predictive than short-term bursts of volatility; consultation with an investment specialist combined with knowledge of the companies in which one has invested can provide a balanced perspective and prudent management of valuable assets.

Terms & Concepts

Bear Market: A prolonged period in which investment prices fall.

Globalization: A term used to express the growing interdependence of people around the world in the realms of society, communication, economy and culture.

Great Depression: A worldwide economic downturn; in the United States, the depression was associated with the stock market crash of 1929 (October 29th, aka Black Tuesday).

Growth Companies: Firms whose business generates considerable positive cash flows, which increase at faster rates than the economy at large.

Investment Company/Firm: A financial entity that sells stock shares to individuals and invests in securities issued by other companies.

Investment Vehicle: Generally, any method used to invest.

NASDAQ: The largest electronic stock-bidding market in the US.

New York Stock Exchange: Nicknamed "The Big Board," is the oldest and largest dollar volume bidding market for stocks in the United States.

Primary Market: Part of the capital markets that issues new securities.

Recession: A decline in general business / economic activity continuing over a period of time.

Secondary Market: Market for trading securities that have already been issued.

Security: An exchangeable, replaceable, negotiable instrument used to represent financial value. Securities are broadly categorized into debt (loan) and equity (ownership) securities. Examples are bonds and common stock respectively.

Security and Exchange Commission: United States government agency that enforces federal securities laws and regulates the stock market.

Stock Market: A market for the buying and selling of stocks, such as the NASDAQ or Dow Jones Industrial exchanges.

Bibliography

Amex members approve buyout by NYSE Euronext. (2008). FOI: Future & Options Intelligence, (1325), 7. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=47251430&site=ehost-live

Antonakakis, N., & Scharler, J. (2012). Volatility, information and stock market crashes. Journal of Advanced Studies in Finance, 3, 49-67. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=84012178&site=ehost-live

Bar-Yosef, S., & Prencipe, A. (2013). The impact of corporate governance and earnings management on stock market liquidity in a highly concentrated ownership capital market. Journal of Accounting, Auditing & Finance, 28, 292-316. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89454723&site=ehost-live

Benston, G. (1990). The separation of commercial and investment banking. The Glass-Steagall Act revisited and reconsidered. Department of Banking and Finance, City University Business School, London. http://www.cftech.com/BrainBank/SPECIALREPORTS/GlassSteagall.html#anchor857855

Clary, I. (2007). Consolidation of exchanges could be N.Y.'s trump card. Pensions & Investments, 35, 30-30. Retrieved September 23, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=26572053&site=ehost-live

Kirby, J. (2007). Let the feasting begin. Maclean's, 120, 30-31. Retrieved September 30, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=26295581&site=ehost-live

Madhavan, A. (2012). Exchange-traded funds, market structure, and the flash crash. Financial Analysts Journal, 68, 20-35. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=79446661&site=ehost-live

Marcial, G. (2007, September 13). After the drop, it's time to stock-shop. Business Week Online, 3. Retrieved September 27, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=26220661&site=ehost-live

Meric, G., Lentz, C., Smeltz, W., & Meric, I. (2012). International evidence on market linkages after the 2008 stock market crash. International Journal of Business & Finance Research (IJBFR), 6, 45-57. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=82250224&site=ehost-live

Naoui, K. (2011). Intrinsic bubbles in the American Stock Exchange: The case of the S&P 500 Index. International Journal of Economics & Finance, 3, 124-132. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=60255631&site=ehost-live

Sloan, A. (2007). These days, the Dow's big swing don't mean a thing. Washington Post. http://www.washingtonpost.com

Steverman, B. (2007, September 7). The street's recession fears. Business Week Online, pp. 29. Retrieved September 27, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=26137067&site=ehost-live

Taylor, C. (2007). Tech stocks tumble as credit fears cause tailspin in worldwide stock markets. Electronic News (10616624), 52, 3-3. Retrieved September 30, 2007, from EBSCO Online Database Academic Search Premier. http://search.ebscohost.com/login.aspx?direct=true&db=aph&AN=26381134&site=ehost-live

Thredgold, J. (2007). Self correcting. Enterprise/Salt Lake City, 36, 9-19. Retrieved September 27, 2007, from EBSCO Online Database Regional Business News. http://search.ebscohost.com/login.aspx?direct=true&db=bwh&AN=24573993&site=ehost-live

Werdigier, J. (2007). NASDAQ is selling Its London stock exchange stake. International Herald Tribune. Retrieved September 27, 2007. http://www.iht.com/articles/2007/08/20/business/exchange.php

Suggested Reading

Dalton, J. (2001). How the Stock Market Works, Third Edition. New York Institute of Finance, Prentice Hall Press.

Sivy, M. (2007). Is it safe yet? Money, 36, 59-62. Retrieved September 30, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26590460&site=bsi-live

Werlin, P. (2007). Bear necessity. Bank Investment Consultant, 15, 41-42. Retrieved September 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=26448701&site=bsi-live

Essay by Nancy Devenger

Nancy Devenger, FACMPE holds a BS degree from the University of New Hampshire and a Masters Degree in Health Policy from Dartmouth College's Center for the Evaluative and Clinical Sciences. Nancy began her career in health care as a registered nurse for many years. Since earning her undergraduate degree in Business, Nancy has worked in private medical practice, home health, consulting, and most currently as Director of Ambulatory Operations for a large Academic Medical Center. Her operational experience as a business manager in private medical practice and for the last decade in a tertiary medical center have allowed Nancy broad insight into both private and academic business endeavors.