Why the world’s largest and most important market is not safe for widows and orphans

The claim that markets are the best and most trustworthy way to allocate resources rests on the idea that willing buyers and willing sellers, with perfect information, in a competitive market, and with enough money to express their needs financially will transact so as to produce an optimal allocation of resources for everyone. Critically, markets will ensure a fair price.

Obviously, there are several caveats in that long sentence that do not sound like a description of the real world. Specifically, they do not sound like a description of the world’s largest and most important market today, the US stock market.

Closer examination suggests that indeed the US stock market today is not fulfilling its primary function which is to present a fair price for investors; it has become a rigged game for insiders and their agents:

• Some individual transactions look extremely suspect;
• Some entire sectors look over-priced;
• The market as a whole seems mis-priced.

We should recognise that, as Ha-Joon Chang wrote in 23 Things They Don’t Tell You About Capitalism, “free markets don’t exist. Every market has some rules and regulations” – and this is for a very good reason: without rules, markets fail society. And some of the most important markets today are doing precisely that.

Some individual transactions look extremely suspect

The Initial Public Offering (IPO) for Elon Musk’s company Space Exploration Technologies Corp (SpaceX) is a clear example.

There was enormous hype about the IPO, and when SpaceX floated on 12 June at a price of  $135 per share, it broke the record for the world’s largest IPO, selling 555 million shares (about 5% of the shares), raising $75 billion and valuing the whole company at $1.77 trillion. This made Musk the world’s first trillionaire.

But not everyone was bullish about the launch. The analysts Morningstar pointed out that SpaceX was not profitable and that its path to a profit that would support a share price of $135 required heroic assumptions – only if the wildest dreams of investors were realised would the stock hold its value.

They said, “The valuation hinges on two unproven technologies: a rapidly reusable Starship upper stage and commercially scalable and competitive orbital AI data centers. We expect neither of these technological questions to be answered before 2028, even in the most optimistic scenario.”  To justify paying the IPO price, you would not only have to believe that SpaceX would  “successfully overcome engineering constraints and rapidly scale orbital data centers to capture 20% of our forecast AI computing capacity by 2040” but also be happy to pay “a $72 per share option premium for SpaceX’s long list of future ambitions (chip fabrication and Mars colonies, for example).”

Perhaps unsurprisingly, the post IPO performance has been poor. The share price is now at $124, below the IPO price. But Morningstar’s estimate of a fair price, given all the uncertainties, was around $63, so there may be much more bad news for investors in the months to come.

What Morningstar could see so clearly, all 23(!) banks and others promoting the IPO could also see, but they made record fees of $500m promoting it to investors. This is not a fair game for ordinary investors to play.

Some whole sectors look over-priced

Two things can simultaneously be true: a new technology can be truly transformative, it can be here to stay; and at the same time, the stock market is over-valuing most stocks in that technology sector.

That was true for the internet in 1999. And many very highly valued internet companies of the time no longer exist – but the internet did not disappear, and its effects have indeed been hugely transformative.

The same may be true today, many AI companies may be over-valued and some may disappear, even though AI itself is here to stay and will almost certainly be transformative. The interconnected financing of the leading ‘frontier’ AI companies and those who provide them the technology infrastructure they need, the ‘hyperscalers’ makes a bubble seem plausible and many commentators have already remarked on the risks.

In its latest annual report, the Bank for International Settlements highlighted the dangers,

“In the near term, the ongoing AI investment boom raises questions about the sustainability of the current economic expansion. The five largest hyperscalers are set to spend over a trillion US dollars on AI-related capital expenditure from 2025 through 2026. These commitments are outpacing earnings and the free cash flow of these firms, leading some to issue debt to raise additional financing (Graph 11.A). This investment race may be partly driven by the perception that only a small number of players with superior technology will ultimately dominate the market shares. The intense competition raises the risk of firms over-committing resources to investment projects with still uncertain returns, leaving all firms vulnerable to disappointments in AI payoffs. Model analysis based on such contest motives highlights the downside risk of current AI exuberance. As competitive pressure drives capex higher, the net economic surplus – the total payoff less investment costs – declines for the sector as a whole and could turn negative in adverse scenarios (Graph 11.B). Disappointment in returns could trigger a sudden pullback in financing and turn the capex boom into a protracted investment bust, with potential knock-on effects on financial conditions.”

And the accompanying charts shows the scale of the issue, the impact of poor returns on investments and a rather scary comparison with past bubbles.

Clearly, there are $billions to be made by the key players before the bubble bursts, but this also does not look like a sector where ordinary investors should be risking their money.

And the wider market also seems risky.

The market as a whole seems mis-priced

The US economist, Robert Schiller, compiles an adjusted version of the price earnings ratio, Cyclically Adjusted Price Earnings (CAPE). There are fundamental reasons why we should expect that most of the time, for most companies, this ratio should be in the teens, and his long-term dataset confirms that for the market as a whole, it usually is.

But not right now. Now it is at levels higher than before the Wall Street Crash, and closer to the Dotcom bubble peak than to the average level.

To make matters even worse, the Trump Regime has been accused of market manipulation through its communications about the state of the war with Iran. And it has recently offered to sell early access to market participants for $100,000 per month, in a move which would make insider trading the only way to play. As one hedge fund manager told the Financial Times, “People will pay because they have to. If you’re behind on that news, you’ll get crushed.” If hedge funds can’t safely trade without that information, what chance have ordinary investors?

Conclusion

The US stock market no longer performs its key function: ensuring that share prices, as far as possible, reflect a fair price, so that US stocks become a reasonable way for ordinary investors to invest their money. It has become a game where insiders can make $billions while ordinary investors lose out. Although most of the stock market is owned by the wealthy, the median American has around 20% of their wealth (and most of their retirement pensions) in their 401K retirement plans, most of which is invested in stocks. So a rigged market hurts normal Americans.

The naïve belief in the power of unregulated markets has been tested to destruction. Markets are not the best way of allocating resources; unless they are tightly managed, they allocate more to the richest and less to everyone else. Our politicians and regulators need not be apologetic about regulating – and they should be far more energetic than they have been. Our report on rewiring the state includes a concrete suggestion for tackling this issue.

If this matters to you, please do sign up and join the 99% Organisation.