7 Stocks, commodities and markets

The efficiency of the U.S. capital market is legendary. His­torically, virtually every major city once had a stock market, but by the 1990s there were only three major markets: New York, New York, Chicago, Illinois and San Francisco, Califor­nia. Local markets persisted in such cities as Boston. Massa­chusetts, and Philadelphia, Pennsylvania, but trading was limited.

Capital markets in the United States have provided much of the money—the lifeblood of capitalism—to finance the building of thousands of factories and plants, research laboratories and office buildings, airplanes and ships. It is fair to say that if capital markets did not exist in the United States, they would have had to be invented. Although in recent years much capital has been raised through bond markets and in other ways, stock markets have often proved to be useful money-raising tools for new struggling companies.

Capital markets are said to be efficient when they can match quickly vast numbers of stocks put forth by sellers with vast demands for stocks put forth by buyers. In part, it is a matter of technology. The modern markets, particularly those in New York and Chicago, rely heavily on computerization each day to process millions of transactions. But also, in part it is a matter of tradition and experience. The stock market works largely on one broker's trust in another broker's word. The brokers, in turn depend on the faith of the customers they represent. Occasionally this trust is abused. But during the last half century, the federal government has played an increasingly important role in insisting on clean dealing and unambiguous language.

This chapter is an attempt to explain how the stock market works.

The principles of this market are similar to all others. For every buyer there has to be a seller. When more people wish to buy than to sell the price tends to rise; when fewer people wish to buy and many wish to sell, the price tends to fall.

Once a company has sold its original stock to the public and it is traded freely in the market, the price will be deter­mined continuously during the trading day by what buyers will pay and what sellers will take. It is simply a matter of supply and demand. Thus, the price is the composite opinion of all the people who buy and sell that stock. Factors that influence how much people will pay include:

• The general business climate or trend, depending on the state of the overall national economy, and the amount of confidence the public has in it;

• The amount of profit the company that issued the stock has been making, or is predicted to make, and its financial condition;

• The rate at which the company is growing or declining;

• The ability of a company to compete successfully with its rivals over a period of time;

• Whether the product or service is one that is popular, and whether the market for that product or service is growing or decreasing;

• The general interest rate, or the market price for bonds;

• The rate of return the company offers compared to the rate of return on alternative investments.