Why doesn't the stock market reflect economic productivity?

Adapted from this imgur thread, which basically asks

Why doesn't the stock market reflect economic productivity?

To understand, let's look at a

Naive model of the stock market

If you've seen the movie Mr. Deeds, it serves as an accessible, simplified, idealized notion of how corporate shares should work: The company operates somewhat democratically, with each share being worth a vote. If you control 50% + 1 of the shares (also called 'stock'), you effectively own the company, because no one can outvote you.

One of the things a burgeoning company might do is keep some stock around, say 20%, labelled 'sell in case of emergency'. In the event of that emergency, the company may exchange the stock for money, used to stimulate business.

But why would strangers part with perfectly good money just to own a tiny fraction of a company if someone else already owns 50% + 1?

Well, there's two types of

Incentives:

  1. Maybe the majority shareholder will sell some shares, and some other individual or group will end up in control. Maybe. Not likely, though.

  2. More likely, the controlling interest will do things to benefit stockholders, like dividends; If business is good, some profit will be split among stock holders.

The original form of this second benefit is the business itself! Maybe you want and end to cancer or safer cars or space exploration, but all you have is money.

So now we have this thing, called a stock, which represent partial control of a company, which is somewhat useful to owners. But, by necessity, stocks are transferable- not just company to holder, but holder to stranger as well. If I own just 2% of Nike, for example, and two factions hold 49% each and can't come to an agreement, how valuable is that 2%? The value is now sky high- less for the aforementioned incentives and more for being the last bit of controlling interest. In fact, any percent would be valuable to either faction, whether from me or even from the other faction.

So stock price, in this naive model, represents how much someone will pay to own a piece (more usually, another piece) of the business. Naturally, a business that is more successful has their price go higher, because controlling interest of the biggest and best is way more valuable than controlling interest in some failed startup.


Here's where we get into trouble:

A type of investor, called a 'Speculator', starts buying stock in hopes the value goes up, not caring at all about ever having controlling interest, or voting, or getting dividends. They operate on the assumption that somebody, someday, somewhere, is going to want those incentives. If the speculator waits for the right time, they can sell it to this new person for way more than the speculator originally paid to buy it.

Example: A $2.1K investment in Microsoft in 1986 could have been sold for $1.4M in 1999 (1).

So for a speculator chasing the dream (500x return on investment) what the company does or how they do it is irrelevant.

Example: Pokemon Go drove Nintendo stock sky high- until investors realized Nintendo had nothing to do with it. From their vantage, it didn't matter how some one would end up using Nintendo stock.

The thing is, though, all of those trades were (presumably) between speculators. And for a speculator, that's fine. Maybe the final payout of the stock is a thousand years from now- doesn't matter. There's always another speculator to sell it to in the mean time. All a speculator has to do is make a teeny tiny return on a HUGE investment, regardless of how they get that return.

So... What if nobody had ever noticed that Nintendo and Pokemon:GO are unrelated?

Speculator could sell to speculator to speculator and so on, with the price just climbing and climbing and climbing. Eventually, it wouldn't matter that the stock is unrelated- the price has gone up time and time again, so even if you know there's no good reason for it to be doing that, it still is doing that. That means you can make $$$.

What's worse is that if Nintendo has no leftover stock to sell, they get NOTHING from all this. The stock market is going freakin' nutso. Meanwhile, at Nintendo HQ, business is doing terrible! Just awful! (It isn't, but for sake of argument we'll say it is).

But things get worse

The stock market seems like this great mythical place where money grows on money and no one ever frowns. Naturally, this attracts more and different kinds of speculators. Sure, some speculators are gross and who cares if their clubhouse burns down, but some are investing the pension fund or university assets or something.

The numbers all show that if we take this money (which is otherwise just sitting in a bank) and buy stocks, we can sell in 10 years for profit. Does anyone really believe that, in ten years, General Motors, Microsoft, Exxon, Boeing, etc are going to be gone? It's a safe, albeit boring investment. So now these massive companies don't just keep us supplied with cars and gas, but by manipulating their stocks with no endgame in mind (we're not trying to get dividends or control, remember) we've entangled our retirements, our houses, our whole economy in the shared success of their stocks.

And as we've seen, the success or failures of their stocks are largely unrelated to the success or failures of their business. So we end up with companies too big to fail and perfectly avoidable collapses and crashes. This volatility is no good. What do we do? Let's manipulate MOAR! Let's make laws and procedures about how to trade, let's have bailouts, let's have collusion between sectors.

Besides all that, let's make sure that some parts do fail, but let's also make sure we aren't liable for them. Once the set up is as tweaked out as a wealthy speculator buying exotic drugs, the numbers can be anything we want.

We basically have controlling interest of the ECONOMY.

What can anyone else do? Are you going to sink this investment and ruin granny's retirement? No. Are you going to oust us and have everyone dump stock? We'll beat you to it and you know it. Besides, who wants another Depression. Oh wait. Us. We want another depression. That'll give us some slack to come up with a new scam. Everybody ready? Operation: Housing Crisis, GO!

Anyway, I hope I am very, very wrong. Because I'm fucking scared. Mostly I'm scared that this perfect engine of poverty will never break.