Has Investing in Stocks Become a Sucker's Bet?

With corporate profits breaking records, Wall Street anxiously anticipates the return of the individual investor to the stock market. It may be a long wait because the little guy may have concluded investing in stocks is a sucker's bet.

In February 1998, the S&P 500 first closed above 1000. From the first quarter of 1998 to third quarter of 2010, corporate profits were up 203%, but the average daily close of the S&P 500 was up only 7% -- about half a percent a year. Buying stocks doesn't seem to pay anymore because most of the increased value created by higher profits has been captured by hedge funds, electronic traders, private-equity funds, and aggressive M&A shops, free standing and at major investment banks, which have multiplied over the last two decades. Their activities, essentially, fall into two categories: aggressive trading -- exploiting complex shorting opportunities, quickly detecting and exploiting movements in trading intentions of large mutual funds and other tactics often associated with exotic hedged bets and electronic trading; and direct asset purchases -- buying underperforming companies, all or in part, to force managers to pay out large sums, rearrange their companies through mergers and divestitures, or exploit unattended business opportunities incumbent managers have been lazy about pursuing. Not all of this is negative to stock prices or unfair. Shrewdly synthesizing public information to identify value in companies ahead of other investors is the way stars like Warren Buffett became legends. Stock prices rise permanently in wake of their actions, and that's good for the ordinary investor already in the stocks they pick. Shaping up underperforming companies likely started even before the first Greek shippers bought out rivals to discharge incompetent captains and reduce seafaring risk, spread overhead and accomplish more leverage with potters, weavers, farmers and foreign merchants. However, too much of a good thing -- electronic trading and aggressive hedging -- can be disruptive. Look at the costs imposed by the May 6 "flash crash" or defensive tactics by corporate managers besieged by unwarranted shorting. And, consider how often private equity and M&A shops acquire companies and load up them with debt, make big payouts to dealmakers, and then later disappoint investors and creditors. 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