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The Stock Market’s Rigged: But Here’s Why It Doesn’t Matter

The stock market has been rigged by crooks for a long, long time. In the 1930s, a wealthy American named Joseph Kennedy played a con-game with stocks as recounted by my American colleague Morgan Housel:

“The repeal of prohibition in 1933 was bound to benefit companies that made supplies needed to make alcohol. One was a bottling company called Owens-Illinois. Rather than investing in directly in Owens-Illinois, Kennedy purchased shares of a company called Libbey-Owens-Ford.

“Libbey-Owens-Ford was an entirely separate company, which manufactured plate glass for automobiles, not bottles, but its name was close enough to the bottle glass company to fool unwary investors,” writes biographer David Nasaw. On news of the repeal, Kennedy and his partners traded shares back and forth between each other, pumping up trading volume to draw attention. That caused other investors to buy shares “on the mistaken belief that they were buying shares of Owens-Illinois, the bottle manufacturer.” After a surge, Kennedy dumped Libbey-Owens-Ford with a $1 million inflation-adjusted profit and invested the proceeds in his original target, Owens-Illinois.”

This act of having partners manipulate share prices of various companies by buying and selling the same block of shares between each other would likely have repeated itself many times since. In the late 1980s and early 1990s, con-man Jordan Belfort used a similar technique to run his fraudulent stock market brokerage firm, Stratton Oakmont; Belfort and his cronies were recently immortalised in a popular Hollywood film, The Wolf of Wall Street. One company that Belfort had ran his scams on was the shoe-fashion designer outfit Steve Madden.

So in a nutshell, stock market fraud has been occurring as early as the 1930s and such acts of mischief are still happening. That sounds scary, doesn’t it? But, it doesn’t matter for investors even if the market’s rigged. Here’s why:

1. The stock market has still managed to build tremendous wealth legitimately for investors despite the presence of scams and frauds.

Since 1930, the S&P 500 (a broad stock market index in the USA) has gone up by 8,745% to its current level of 1,857 points. Kennedy and Belfort and other similar fraudsters could have wreaked as much havoc as they wanted with their scam games, but that hasn’t stopped American corporations from legitimately building great wealth through the years.

It’s the same with Singapore as well. The first S-chip (S-chips are Singapore-listed companies that are based in China) scandal was unearthed in 2007 and since then, plenty more have occurred. One of the most recent ones involve Eratat Lifestyle (SGX: FO8), a China-based company that’s supposedly in the fashion business. Shares of the company were suspended from trading in January this year after the company defaulted on interest-payments on its high-yield bonds and fabricated its bank account balances.

Besides S-chips, there’s also the matter concerning potential manipulation of penny shares in Singapore with Blumont Group (SGX: A33), Asiasons Capital, and LionGold Corp being emblematic of the situation. Investigations are currently ongoing regarding last October’s stunning 90%-plus collapse in share prices within three days for the trio; prior to their collapse, shares of the three companies had all increased in prices rapidly with Blumont in particular climbing close to 4,000% in less than a year. It’s unknown what the investigations might eventually uncover.

With the S-chip and penny share scandals, it wouldn’t be a stretch to say that both would likely have at least germinated the idea amongst retail investors here that the local market’s rigged in certain ways.

And yet, the Straits Times Index (SGX: ^STI) has jumped by some 292% in 25-plus years from 834 points at the start of 1988 to its current level of 3,266 points.

United Overseas Bank

Keppel Corporation

Jan 1994: EPS*

S$0.52

S$0.26

Today: EPS*

S$1.95

S$1.01

Change in EPS

275%

292%

Jan 1994: Share price**

S$4.05

S$1.57

Today: Share price

S$22.51

S$10.58

Change in share price

456%

574%

*EPS = earnings per share

**Share prices in Jan 1994 have been adjusted for dividends, splits, rights issues and spin-offs

Source: S&P Capital IQ

Individual companies like United Overseas Bank (SGX: U11) and Keppel Corporation (SGX: BN4), just to name a few, have also been solid long-term winners over the past 20 years – as shown in the table above – as they built their businesses and grew their profits through proper means.

2. With a long time-horizon, even a company that’s the target of stock market scam artists can prove to be immensely profitable.

Morgan recounted in his article how Libbey-Owens-Ford, as a business, had earned US$1.1 million in profits in 1933. By 1985, the company’s profits had ballooned to more than US$70 million.

With Steve Madden, the firm had a market capitalisation of around US$42 million when Belfort ran his scam on the company in Dec 1993.Today, Steve Madden has a market capitalisation of US$2.2 billion.

As Morgan wrote in his article, “Getting tricked by Kennedy didn’t matter much if you were willing to wait.”

Foolish Bottom Line

There’ll likely be no end to having unscrupulous stock market manipulators appear to rig parts of the market. But, it is possible to stay away from manipulated-shares and come out ahead. And, like we’ve seen with Libbey-Owens-Ford and Steve Madden, even companies that are the victims of manipulation can still do great things for investors for those who are willing to wait.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Chong Ser Jing doesn’t own shares in any companies mentioned.