As stock markets hit the headlines this week due to wild swings in their fortunes, a question arises whether these indices have much value in evaluating real economic activity. And might not an index that measures the performance of family businesses be a better way of evaluating future economic activity?
Journalists have relished telling us how much money was wiped off the big stock market indexes this week. Inevitably such market volatility prompts questions about its effect on economic activity. After all, stock market crashes in the past have led to serious economic recessions and even depressions. This time around, most are saying the world economy will be little affected because the fundamentals of the big economies continue to remain strong.
But perhaps everyone is missing the point about the link between the performance of stock markets and the real economy - at least in the 21st century. Aren’t we not over-emphasizing the link? Probably, and here’s why. Although stock market capitalisation levels might have risen as a percentage of GDP in most economies since the 1980s, the number of listed businesses has fallen. And this fall is most notable in the US, which has the world’s biggest stock market. Indeed, the number of US-listed companies has shrunk dramatically to around 3,700 today, compared with more than 7,300 in 1996.
OK, things picked up last year when global initial public offerings rose by 44% from the previous year with almost 1,700 companies floated. That will hopefully spark an even bigger renewal in enthusiasm for public markets in the future, but it’s unlikely to make them a better lead indicator of the health of economies. That’s because so much of the world’s economy today is driven by privately controlled businesses.
As an indication of this, there are at least 30 million businesses in the US, but, as we mentioned above, less than 4,000 of them are listed. OK, most of these businesses are small, employing less than 50 people, but many of them are also big, and some are as big as those listed, if not bigger. That begs the question, wouldn’t a better indicator of the health of an economy be something that monitors the collective performance of these businesses more precisely than is currently done?
Surely it is possible - advances in Big Data should make it so - to sample sales and employment growth in say 5% of these businesses. And if so, then that should create a much better indicator of the economic prospects of the US economy, and likewise for any other economy with a similar dataset. And there’s no reason why other data points could not be added like inventory levels and supplier payment delays.
Narrow down that sample with just family businesses employing 100 people and more than that indicator of the health of a world economy could even be better. That’s because family businesses are more likely to take a long-term approach to managing their businesses and hold onto staff more readily than non-family businesses when experiencing differences. So, if family businesses are seeing sales fall and making redundancies than an economy would be in for a much rougher patch then that indicated from a rapid fall in an economy’s stock market index.
Of course, such an index would be a lot less interest to investors as most of the companies in the index would be privately owned and impossible to invest into directly. But that doesn’t matter, what it should tell investors - and, more importantly, the general public - is the real strength or weakness in an economy.
Is this not an idea for one of those Big Data startups?