The Biggest Personal Finance Story of the Past 30 Years - Part 2
To understand what has happened to the market valuation of the financial services sector, particularly over the last 30 years, you should view Figure 4 on page 16 of the financial study by Jeremy Siegel and Jeremy Schwartz entitled: The Long-term Returns on the Original S&P 500 Firms.
Click the link to this .pdf document in the previous sentence, and a separate browser window will pop up. After you have studied Figure 4, then continue reading this article on The Skilled Investor.
By the way, in addition to the point we are making with Figure 4, the rest of this Siegel and Schwartz paper is well worth reading. This study shows that revisions of the S&P500 index over time have not enhanced the value of the index:
1) because new stocks tend to be added when relative valuations are peaking, and
2) because of the market trading impact of index funds that must buy these newly added firms, while they jettison those that are removed from the index.
In addition, this study is yet another proof that a passive, low cost, buy-and-hold strategy is superior over the long haul to all this frenetic active investing that individuals and investment funds do.
When you looked at Figure 4 of the Siegel and Schwartz paper, did anything seem stunning to you? I was stunned, when I first saw this graphic. Figure 4 shows that the “Financial” sector grows from next to nothing to become about 20% of the value of the S&P 500 by 2003. No other sector grows like this. Health Care expands, but not at as high a rate as Financials. Info Tech expands over the long-term but not at as high a rate as Financials. This graphic also shows how the boom and bust of the Info Tech bubble temporarily displaced the percentage market share of all the other sectors.
Beside Financials, Health Care, and Info Tech, all of the other sectors shrink in percentage terms over the 45 years of S&P 500 market capitalization percentage data that are presented in Figure 4 of the Siegel and Schwartz paper.
As of July 2007, the S&P 500 Fact Sheet on the Standard & Poors website indicated that Financials currently represented 20.77% of index market capitalization. The next four largest sectors in order of percentage market capitalization are:
1) Info Tech at 15.45%,
2) Health Care at 11.67%,
3) Industrials at 11.43%, and
4) Energy at 10.79%.
Concerning these four other sectors listed above, for years, we have very often heard about:
1) Info Tech sector — the growth, market bubble, and crash of the information technology sector with all its increasing technological marvels and productivity contributions to the world economy;
2) Health Care sector — the continually escalating costs of the U.S. health care system, the aging of the population and attendant medical costs, and the growing crisis of millions of uninsured and underinsured people;
3) Industrials sector — the continuing migration of industry manufacturing overseas with outsourcing, dramatic job losses, and huge balance-of trade-deficits; and
4) Energy sector — the escalating price of gasoline, natural gas, and heating oil, the negative impact of energy costs on consumer spending and economic growth, and quarterly record after quarterly record of energy company profits.
Yet, at the same time, the Financial sector has grown to be almost twice the value of the Energy sector in S&P500 market capitalization. Nevertheless, we have not heard a widespread media clamor about escalating financial services costs and profits. Instead, all we hear about are financial scandals related to greed, fraud, and scams. Even then, many of these scandals have faded from memory, as securities market values have risen in recovery following the market bust.
Why don’t we hear about the real financial sector scandal, which is the huge, growing, and continuous wealth transfer from individuals to financial intermediaries through exorbitant visible and hidden fees and costs? The financial media rarely focuses on exorbitant financial costs. Instead, we get “perp walks” of high profile fraudsters. It is as if we can just weed out some bad apples and get back to business as usual.
Catch John Rigas, Ken Lay, Martha Stewart, Dennis Kozlowski, and on and on. Walk them in handcuffs or prison fatigues before the cameras, and then everything will be okay. With regulatory and judicial slaps on the wrist, everything will be OK, if we can just stop the more visible scandals of mutual fund market timing, corporate accounting funny business, broker sales incentives, soft dollar payments, Richard Grasso’s compensation, etc.
Well, Figure 4 of the Siegel and Schwartz paper shows that things will not be okay after a few tweaks to the regulatory system and a few perp walks. Individuals have in the past and apparently will in the future continue to pay exorbitant banking, credit card, insurance, and securities costs. The wealth transfer will continue unabated.
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Comment by KCLau
1 August 13, 6:39 pm o'clock |
I am naive about this story. Do mean that growth of financial sector is not a good thing?
Comment by The Skilled Investor
2 August 13, 10:28 pm o'clock |
Hi KCLau,
A capitalist economy needs a viable and efficient financial sector. However, when financial services grows more rapidly than any other economic sector within the S&P 500, which accounts for 75% of U.S. market capitalization, something is out of whack. When financial services becomes 21% of the index and twice the capitalization of the energy industry, something is out of whack.
Individuals in general pay excessive financial fees, which provide a continuous wealth transfer from the pockets of the general population into the pockets of the employees and owners of financial services industry firms.
Businesses, government, and institutions should be in a better position to negotiate more favorable terms. Some do this well, and others do this poorly. When businesses and institutions pay excessive financial fees, the wealth transfer simply takes an indirect form.
Excessive financial fees paid by businesses, government, and institutions reduce profits and consume budgets. Equity values are reduced. Excessive financial fees also reduce cash flow, which tends to reduce credit quality and to drive up the cost of debt. Ultimately, either directly or through trusts and other institutions, individuals own diminished equity and more expensive debt, when financial fees are excessive.
The only winners are those who drive their own financial costs down, get similar quality but less costly financial services, and refuse to give away their wealth unnecessarily. Simultaneously, if they own the broad market including financial services equities, they will benefit from some of the excessive payments made by other people.
Whether this disproportionately rapid growth in the financial services sector will continue is anyone’s guess. However, when the financial services sector is larger than each of the technology, health care, industrials, and energy sectors — and all other sectors as well, then frankly millions of naive pockets are being picked. People need to wake up. They are paying far more than they get in return.
Comment by Aaron
3 August 15, 8:01 pm o'clock |
The growth of the financial services industry is certainly one that does not get the same type of press that the energy one does. Healthcare will likely continue to expand in the coming years as well with the baby boomer population growing older.
Comment by Carnival of Smart Money #1
4 August 28, 9:25 am o'clock |
Larry Russell presents The Biggest Personal Finance Story of the Past 30 Years (Part 2) posted at THE SKILLED INVESTOR Blog, saying, “The biggest personal finance story of the past 30 years has been the dramatic growth of the market capitalization of financial services firms within the U.S. equity markets.
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