6.8 Stock market development
10 min read•august 21, 2024
The stock market's development in America transformed how businesses raised capital and investors participated in ownership. From early exchanges to modern electronic trading, this evolution reshaped the financial landscape, enabling economic growth and innovation.
Regulatory frameworks, market indicators, and technological advancements have profoundly impacted trading practices. Understanding these elements is crucial for grasping the stock market's role in shaping American business history and its ongoing influence on the economy.
Origins of stock trading
- Stock trading emerged as a crucial component of American business history, facilitating capital formation and economic growth
- The development of stock exchanges revolutionized how companies raised funds and how investors participated in business ownership
- Early stock trading practices laid the foundation for modern financial markets and corporate structures
Early stock exchanges
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- Amsterdam Stock Exchange established in 1602 served as a model for future exchanges
- Philadelphia Stock Exchange founded in 1790 became the first organized stock exchange in the United States
- Traders initially met under a buttonwood tree on Wall Street in New York City to buy and sell securities
- Open outcry system used for price discovery and trade execution
- Limited number of stocks traded, primarily government bonds and bank shares
Joint-stock companies
- Emerged in the 16th and 17th centuries as a way to pool capital for large-scale ventures
- Dutch East India Company (VOC) pioneered the joint-stock model in 1602
- Allowed investors to purchase shares and receive dividends based on company profits
- Limited liability concept protected shareholders from losing more than their initial investment
- Facilitated the financing of risky ventures (colonial expeditions, railroads)
- Separation of ownership and management led to the development of modern corporate structures
Rise of Wall Street
- Wall Street transformed from a small trading post to the global financial center of the United States
- The growth of Wall Street paralleled the rapid industrialization and economic expansion of America
- Wall Street's dominance in finance significantly influenced American business practices and economic policies
New York Stock Exchange
- Formally organized in 1817 with the signing of the Buttonwood Agreement
- Moved to its iconic location at 11 Wall Street in 1903
- Implemented listing requirements to ensure quality of traded securities
- Introduced specialists to maintain orderly markets and provide liquidity
- Seat system limited membership and created a valuable asset for brokerage firms
- Transitioned from call market to continuous trading to accommodate increased volume
Rival exchanges
- Regional exchanges emerged to serve local markets (Boston, Chicago, San Francisco)
- Curb market (later American Stock Exchange) operated outdoors for unlisted securities
- Over-the-Counter (OTC) market developed for trading stocks not listed on major exchanges
- founded in 1971 as the world's first electronic stock market
- Competition between exchanges drove innovation in trading practices and technology
Key market innovations
- Technological advancements in stock trading significantly impacted market efficiency and accessibility
- Innovations in information dissemination and trade execution reshaped the financial landscape
- These developments democratized investing and increased market liquidity
Ticker tape
- Introduced in 1867 by Edward Calahan of the American Telegraph Company
- Transmitted real-time stock prices across long distances using telegraph technology
- Revolutionized the speed of information flow in financial markets
- Ticker tape parades became a cultural phenomenon celebrating major events
- Mechanical tickers replaced by electronic displays in the 1960s
- Remnants of ticker tape still visible in modern stock tickers and financial news crawls
Electronic trading
- Computerized order matching systems introduced in the 1970s
- NASDAQ pioneered fully electronic trading for over-the-counter stocks
- NYSE introduced SuperDOT system in 1984 for electronic order routing
- Decimalization of stock prices in 2001 increased price granularity and reduced spreads
- Dark pools emerged as alternative trading venues for large institutional orders
- High-frequency trading algorithms execute trades in microseconds, increasing market liquidity
Market regulations
- Government intervention in financial markets aimed to protect investors and maintain market integrity
- Regulatory frameworks evolved in response to market abuses and economic crises
- The establishment of federal oversight marked a significant shift in American business regulation
Securities Act of 1933
- Passed in response to the 1929 stock market crash and subsequent
- Required companies to provide full disclosure of material information when issuing securities
- Established registration process for new securities offerings
- Prohibited fraudulent practices in the sale of securities
- Created civil liability for false or misleading statements in registration statements
- Exempted certain small and private offerings from full registration requirements
SEC establishment
- Securities and Exchange Commission created by the Securities Exchange Act of 1934
- Granted broad authority to oversee and regulate securities markets
- Implemented rules for stock exchanges, broker-dealers, and investment advisers
- Enforced laws against market manipulation and
- Required public companies to file periodic financial reports (10-K, 10-Q)
- Established proxy rules to protect shareholder voting rights
- Created EDGAR system for electronic filing and public access to corporate disclosures
Bull vs bear markets
- Bull and bear markets represent cyclical patterns in stock market performance
- These market cycles significantly impact investor sentiment and economic conditions
- Understanding market trends is crucial for developing investment strategies
Notable bull markets
- 1920s fueled by post-World War I economic boom and technological innovations
- 1950s-1960s bull run driven by post-World War II economic expansion
- 1980s-1990s bull market propelled by technology sector growth and low inflation
- 2009-2020 bull market following the Great Recession, longest in U.S. history
- Characteristics include rising stock prices, increased investor confidence, and economic expansion
- Often accompanied by increased merger and acquisition activity and initial public offerings (IPOs)
Major market crashes
- Panic of 1907 triggered by failed attempt to corner United Copper Company stock
- 1929 stock market crash led to the Great Depression
- Black Monday in 1987 saw fall 22.6% in a single day
- burst in 2000 wiped out trillions in market value
- resulted from subprime mortgage meltdown and credit crunch
- Factors contributing to crashes include overvaluation, excessive leverage, and economic shocks
- Market crashes often lead to regulatory reforms and changes in investor behavior
Impact on American economy
- The stock market plays a vital role in shaping the American economic landscape
- Stock market performance often serves as a leading indicator of economic health
- The interplay between financial markets and the real economy influences policy decisions
Capital formation
- Stock markets provide a mechanism for companies to raise capital through initial public offerings (IPOs)
- Secondary market trading allows for continuous valuation of companies
- Enables firms to fund expansion, research and development, and capital investments
- Venture capital and private equity firms use public markets as exit strategies
- Stock-based compensation aligns employee interests with company performance
- Market valuations influence mergers and acquisitions activity
Wealth distribution
- Stock ownership broadened through mutual funds and retirement accounts
- 401(k) plans shifted retirement savings from pensions to individual investment accounts
- Wealth inequality exacerbated by differences in stock market participation rates
- Stock market gains contribute to the wealth effect, influencing consumer spending
- Corporate stock buybacks impact earnings per share and wealth concentration
- Market volatility can disproportionately affect different socioeconomic groups
Stock market indicators
- Market indicators provide insights into overall stock market performance and economic trends
- These benchmarks serve as important tools for investors, analysts, and policymakers
- Understanding market indicators is crucial for interpreting financial news and making investment decisions
Dow Jones Industrial Average
- Created in 1896 by Charles Dow, initially included 12 industrial companies
- Now comprises 30 large, publicly-owned companies trading on NYSE and NASDAQ
- Price-weighted index, giving higher-priced stocks more influence
- Components changed periodically to reflect changes in the economy
- Criticized for narrow representation but widely followed due to historical significance
- Dow Jones Transportation Average and Dow Jones Utility Average complement the Industrial Average
S&P 500
- Introduced in 1957 by Standard & Poor's, expanded from earlier indices
- Includes 500 large-cap U.S. stocks, covering about 80% of American equity market capitalization
- Market-cap weighted index, reflecting the true market value of component companies
- Rebalanced quarterly to maintain representation of various sectors
- Widely regarded as the best single gauge of large-cap U.S. equities
- Used as a benchmark for index funds and as a barometer of overall market performance
Technological advancements
- Technological innovations have dramatically transformed stock trading practices
- These advancements have increased market efficiency, reduced costs, and expanded access to financial markets
- The rapid pace of technological change continues to reshape the investment landscape
High-frequency trading
- Utilizes powerful computers and complex algorithms to execute large numbers of trades in microseconds
- Exploits small price discrepancies and market inefficiencies
- Accounts for a significant portion of daily trading volume on major exchanges
- Provides liquidity and narrows bid-ask spreads in many securities
- Raises concerns about market fairness and potential for market manipulation
- Led to the development of new market structures (dark pools, alternative trading systems)
Online brokerages
- Emerged in the 1990s, revolutionizing retail investor access to financial markets
- Reduced trading costs dramatically compared to traditional full-service brokers
- Provided real-time quotes, research tools, and educational resources to individual investors
- Mobile trading apps further increased accessibility and convenience
- Commission-free trading models disrupted traditional brokerage business
- Gamification of trading platforms raised concerns about encouraging excessive risk-taking
- Facilitated the rise of social media-driven investment trends (meme stocks)
Market globalization
- Globalization of financial markets has increased interconnectedness of economies worldwide
- Cross-border capital flows have grown significantly, influencing investment opportunities and risks
- Global market integration has implications for diversification strategies and regulatory coordination
International stock exchanges
- Major global exchanges include London Stock Exchange, Tokyo Stock Exchange, and Shanghai Stock Exchange
- Emerging market exchanges gained prominence (Bombay Stock Exchange, São Paulo Stock Exchange)
- Cross-listings allow companies to access capital in multiple markets
- American Depositary Receipts (ADRs) enable U.S. investors to own foreign stocks
- Exchange-traded funds (ETFs) provide easy access to international markets
- Time zone differences allow for nearly 24-hour trading across global markets
Cross-border trading
- Technological advancements facilitated seamless international transactions
- Increased correlation between global markets during times of financial stress
- Regulatory differences between countries create arbitrage opportunities
- Currency fluctuations impact returns for international investors
- Global financial centers (New York, London, Hong Kong) compete for listings and trading volume
- International mergers between exchanges (NYSE-Euronext) create global trading platforms
Investor psychology
- Psychological factors play a significant role in stock market behavior and individual investment decisions
- Understanding investor psychology is crucial for developing effective investment strategies
- Behavioral finance has emerged as a field studying the impact of psychology on financial markets
Speculation vs investment
- Speculation focuses on short-term price movements and higher risk-reward ratios
- Investment emphasizes long-term value creation and fundamental analysis
- Speculative bubbles occur when asset prices exceed intrinsic value (tulip mania, dot-com bubble)
- Value investing strategy seeks undervalued stocks for long-term appreciation
- Growth investing targets companies with high potential for future earnings growth
- Balancing speculative and investment approaches crucial for portfolio management
Market sentiment
- Reflects the overall attitude of investors toward a particular security or financial market
- Indicators include put/call ratio, VIX (volatility index), and investor surveys
- Contrarian investing strategy aims to profit from extreme market sentiment
- Herd behavior can lead to market overreactions and price bubbles
- Fear and greed cycle influences buying and selling decisions
- Media coverage and social media discussions impact short-term market sentiment
Corporate governance
- Corporate governance structures significantly impact stock performance and investor confidence
- The relationship between shareholders, management, and boards of directors shapes company policies
- Good corporate governance practices are essential for maintaining market integrity and investor trust
Shareholder rights
- Voting rights allow shareholders to elect board members and approve major corporate actions
- Proxy voting enables shareholders to participate in corporate decisions without attending meetings
- Shareholder proposals can influence company policies on environmental, social, and governance issues
- Cumulative voting gives minority shareholders greater representation in board elections
- Appraisal rights protect shareholders in merger and acquisition transactions
- Class action lawsuits provide a mechanism for shareholders to seek redress for corporate misconduct
Board of directors
- Elected by shareholders to oversee management and protect shareholder interests
- Responsibilities include setting strategic direction, hiring/firing CEO, and ensuring financial integrity
- Independent directors provide objective oversight and reduce conflicts of interest
- Board committees (audit, compensation, nominating) focus on specific governance areas
- Staggered boards with multi-year terms aim to provide continuity and resist hostile takeovers
- Board diversity initiatives seek to improve decision-making and representation
Market manipulation
- Market manipulation undermines the integrity of financial markets and erodes investor confidence
- Regulatory bodies actively monitor and enforce rules against manipulative practices
- Understanding common manipulation tactics helps investors protect themselves and maintain market fairness
Insider trading
- Trading based on material, non-public information about a company
- Illegal when conducted by corporate insiders or those who misappropriate information
- SEC Rule 10b5-1 allows for pre-planned trading by insiders to avoid appearance of impropriety
- High-profile cases (Ivan Boesky, Martha Stewart) increased public awareness of insider trading
- Whistleblower programs incentivize reporting of insider trading violations
- Regulatory challenges in proving intent and defining material information
Pump and dump schemes
- Artificially inflate the price of a stock through false or misleading statements
- Often target small-cap or penny stocks with low liquidity
- Perpetrators sell their shares at inflated prices, leaving other investors with losses
- Social media and online forums used to spread misinformation and hype stocks
- Boiler room operations use high-pressure sales tactics to push fraudulent investments
- Regulatory efforts focus on educating investors and prosecuting scheme organizers
Key Terms to Review (18)
2008 financial crisis: The 2008 financial crisis was a severe worldwide economic downturn that began in the United States, marked by the collapse of major financial institutions, significant declines in consumer wealth, and a sharp downturn in economic activity. This crisis resulted from a combination of factors, including high-risk mortgage lending, complex financial products, and a lack of regulatory oversight, leading to a profound impact on both the financial sector and global economies.
Bear market: A bear market is a period of declining prices in the stock market, typically defined as a drop of 20% or more from recent highs. This condition can signal a lack of investor confidence and may lead to widespread selling, further driving down prices. Bear markets can be driven by various factors, including economic downturns, rising interest rates, or geopolitical events, and they often coincide with recessions.
Bull market: A bull market refers to a financial market condition characterized by rising prices, typically over an extended period. This phenomenon often indicates strong investor confidence and a robust economy, leading to increased buying activity in stocks, commodities, and other assets. During a bull market, optimism prevails, driving more investors to enter the market, which further fuels price increases.
Dot-com bubble: The dot-com bubble refers to a period of excessive speculation in the late 1990s and early 2000s, characterized by a rapid rise in equity markets fueled by investments in internet-based companies. This surge was driven by advancements in communication technologies and the computer revolution, leading to an influx of venture capital into startups, ultimately resulting in inflated stock prices and a dramatic market crash in 2000.
Dow Jones Industrial Average: The Dow Jones Industrial Average (DJIA) is a stock market index that measures the performance of 30 large, publicly-owned companies trading on the New York Stock Exchange and the NASDAQ. It serves as one of the most widely recognized indicators of stock market performance and overall economic health in the United States, reflecting trends and investor sentiment.
Great Depression: The Great Depression was a severe worldwide economic downturn that began in 1929 and lasted through the late 1930s, marked by widespread unemployment, significant declines in industrial production, and deflation. This period dramatically reshaped American society and led to major changes in government policies and labor movements.
Initial public offering (IPO): An initial public offering (IPO) is the process through which a private company offers its shares to the public for the first time, transitioning into a publicly traded company. This event allows the company to raise capital from public investors while providing an opportunity for early investors and employees to sell their shares. The significance of IPOs extends beyond just fundraising; they often reflect market conditions and investor sentiment, influencing stock market dynamics and the overall economy.
Insider trading: Insider trading refers to the buying or selling of publicly-traded securities based on non-public, material information about a company. This practice can undermine investor confidence and market integrity, as it creates an uneven playing field where insiders benefit at the expense of regular investors. Laws and regulations are in place to detect and penalize insider trading, highlighting the importance of maintaining fair practices in the stock market and financial system.
J.P. Morgan: J.P. Morgan was a prominent American banker and financier in the late 19th and early 20th centuries, known for his significant influence in the financial sector and his role in consolidating various industries. He played a critical role in shaping the modern corporate landscape by reorganizing struggling companies and creating powerful trusts and holding companies, especially in the steel industry. His financial strategies contributed to the stability and growth of the stock market during turbulent economic times.
NASDAQ: NASDAQ, short for the National Association of Securities Dealers Automated Quotations, is an electronic stock exchange that facilitates the buying and selling of stocks and other securities. It was founded in 1971 and is known for being the first electronic exchange, which revolutionized the trading process by providing a fully automated platform for market transactions, contributing to the overall development of stock markets in the United States and beyond.
New York Stock Exchange: The New York Stock Exchange (NYSE) is one of the largest and most prestigious stock exchanges in the world, located on Wall Street in New York City. It plays a critical role in stock market development by facilitating the buying and selling of shares of publicly traded companies, which helps to provide capital for businesses and investment opportunities for individuals. As a symbol of financial power and economic growth, the NYSE was significantly impacted by events like the Panic of 1873, which revealed vulnerabilities in the financial system and led to widespread economic turmoil.
S&P 500: The S&P 500, or Standard & Poor's 500, is a stock market index that measures the stock performance of 500 of the largest publicly traded companies in the United States. It serves as a benchmark for the overall health of the U.S. stock market and is widely regarded as one of the best representations of the American economy.
Sarbanes-Oxley Act: The Sarbanes-Oxley Act is a U.S. federal law enacted in 2002 to protect investors from fraudulent financial reporting by corporations. This legislation introduced significant reforms to enhance corporate governance, improve financial disclosures, and establish stricter penalties for corporate fraud, especially in the wake of major accounting scandals that shook investor confidence.
SEC (Securities and Exchange Commission): The SEC is a U.S. government agency responsible for regulating the securities industry, protecting investors, and maintaining fair and efficient markets. Established in 1934 during the Great Depression, it plays a crucial role in overseeing the stock market's development by enforcing securities laws and ensuring transparency in financial reporting.
Securities Act of 1933: The Securities Act of 1933 was a landmark legislation aimed at regulating the securities industry and ensuring transparency in financial markets. It required companies to provide full and fair disclosure of information to investors when offering securities for sale, aiming to restore public confidence in the capital markets after the stock market crash of 1929. This act laid the groundwork for limited liability, stimulated stock market development, and led to the establishment of the Securities and Exchange Commission to oversee compliance and protect investors.
Short selling: Short selling is an investment strategy that involves borrowing shares of a stock and selling them with the intention of buying them back later at a lower price. This practice allows investors to profit from the decline in the stock's price. It plays a significant role in stock market development by providing liquidity and allowing for price discovery, while also introducing elements of risk for both the investor and the overall market.
Stock market crash of 1929: The stock market crash of 1929 was a severe downturn in stock prices that occurred in late October, marking the beginning of the Great Depression. It reflected the speculative bubble in the stock market, where rapid price increases led to unsustainable valuations, causing widespread panic and the collapse of investor confidence. This event is crucial as it revealed the vulnerabilities in financial markets, prompted regulatory changes, and significantly impacted the economic landscape of the United States and beyond.
Warren Buffett: Warren Buffett is a prominent American investor, business tycoon, and philanthropist, widely recognized as one of the most successful investors in history. He is the chairman and CEO of Berkshire Hathaway, a multinational conglomerate holding company, where his investment philosophy emphasizes long-term value investing, a focus on fundamental business analysis, and a commitment to ethical corporate governance. Buffett's strategies have significantly influenced stock market development and established him as a key figure in the financial sector.