Past Performance Is Not Indicative of Future Results, Unless Government Props You Up

Nov 6, 2019 | Blog | 0 comments

One January, a farmer decided to invest in the stock market. He’d had a bumper crop, and he wanted to shore up his financial future, planning for the time when providence would not be so kind. Knowing he wouldn’t have time to watch the market during the growing season, he did some research and invested heavily in a nice safe company: one that had a growth trend and had been named Fortune’s “Most Innovative Company” for six years.

That same January, a day trader wanted to make some long-term investments that he could keep on the back burner. He knew the experts were all abuzz regarding an industry-changing technology with huge growth potential. He invested in several up-and-coming companies based around this technology, certain he’d have a nice nest egg, should he ever fall on hard times.

Finally, a seasoned investor decided to divide his portfolio among dozens of strong companies. Wanting to keep his portfolio diverse, he also bought stocks in several small and struggling companies, hoping that one or more would grow or rebound.

The year was 2001. The company the farmer invested in was Enron. His stock went from more than $80 a share down to $0.63 in a single year. The farmer recouped less than a penny on the dollar.

The day trader invested in DVD’s – both in the technology itself, and in companies like Blockbuster, which relied on them. His decline was neither as sudden nor as deep as the farmer’s, but nonetheless, he lost a great deal of money. He might have hit it big the next year had he also invested in Netflix (a company that originally relied on DVD rentals, but quickly evolved to newer streaming technology and expanded into content creation), but he felt his eggs were secure in the more established Blockbuster basket.

Our seasoned investor, with his diversified portfolio, bought stock in Walmart, which was strong in 2001 and remained strong in 2019. He also chose a struggling Apple, as a low-risk high-reward bet. It payed off quite well. While several of his bets lost, the big gains were enough to overcome the losses.

What’s the Lesson?

Each of the three investors represents one of three different “pro-business” economic policies.

The farmer’s investment in Enron represents faith in closing funds, a government policy where someone (often the governor) has the power to give money to a favored business to attract them to, or keep them in, the state. Recipients are usually established companies. However, history shows that these businesses are often looking to move because they failed to keep up with the times. The two biggest recipients of Oklahoma’s closing fund are Macy’s (down from $68 per share in 2015 – the year Oklahoma gave it the subsidy – to $15 per share this week) and GE (down to $10 a share now from $25 a share in 2014, the year it was subsidized).

Unlike the farmer, the day trader who invested In Blockbuster represents faith in industry incentives, like those for wind energy, or film. Even though these funds are diversified across companies, they are often used to encourage investment in industries that either aren’t economically viable, or are firmly entrenched in other states. States spend taxpayer money on industries that don’t work in the state – or just don’t work.

Most importantly, the seasoned trader represents a low tax rate policy. In contrast to closing funds and industry incentives, a low tax rate does not target a specific audience or give special privilege. A low tax rate makes a state welcoming to all businesses – the government equivalent of a diverse portfolio. This allows businesses to decide if a state offers them natural advantages over another location – and keeps the state open to innovative new ideas. This is better than luring aging behemoths to the state just in time to give their last gasp.

Takeaway

Closing funds and industry incentives are not sound state “investments” (a misnomer, since states rarely recoup their investments). Even stock brokers depend on wide diversification across industries when picking winners and losers. Consider this: whenever you see an ad for stock brokers, you see a disclaimer that “past performance is not indicative of future results.” In other words, the brokerage doesn’t want you blaming them when you buy stock in a Fortune 500 company at their peak price and lose your shirt when they can no longer compete in a changing marketplace. Why would government fare any better?

The average time a company will spend on the Fortune 500 list is shrinking (for those that make it at all). The turnover rate between 1955 and 2019 was almost 90% – that is, only 10% of companies (52 of 500) managed to stay in that elite group for 60 years. Government officials like to think they can pick winners and losers – or that their influence can transform losers into winners. History shows they cannot.

Corporate Welfare is not a solid strategy for state economic growth. It is, at best, rewarding businesses for past success. Unfortunately, this helps stagnating, formerly-great companies stay in the market for too long, when their resources would be better off used by new and innovative competitors. This slows innovation and hurts the economy. Oklahoma and its local governments should instead eliminate incentives to specific companies and use the savings to lower the tax rates for all businesses. While politicians will have fewer ribbon cutting ceremonies to attend, it’s sound fiscal policy. It’s also the right thing to do.

Mike Davis is the 1889 Institute Research Fellow. He can be reached at mdavis@1889institute.org.