We’ve seen this logic invoked before when Obama has talked about gun control, and as a result, gun sales have risen and the share price of gun maker stocks have gone up. Something about it has always rubbed me the wrong way, but I didn’t really put it all together until today.
The core premise is that when Obama threatens gun control, it causes people to hurriedly buy guns out of fear that, in the near future, they might have difficulty buying said guns. Therefore, sales spike, and since sales are up, shares in the companies who make the guns go up. But there is a fundamental problem in this analysis – the increased sales are not additional sales. No new demand is created. These are people who planned, at some point, on buying guns anyway – they just have to do it sooner rather than later.
In economics, this is known as “demand shifting.” The most famous example of government policy leading to demand shifting is probably the much lauded “cash for clunkers” program, which it turned out didn’t really help the economy in the long-term at all. It didn’t cause people who weren’t going to buy cars at all to buy them – rather it just caused people who were going to buy a car anyway to do so sooner than they otherwise would have. So a particular company, let’s say Ford, sells more cars than they would have today, but it comes at the cost of selling fewer cars than they otherwise would have in some future period.
But let’s leave cars behind and return to gun stocks. I don’t want to get too into the weeds of your intro college finance course, but let’s review some of the basic concepts involved here. A stock is essentially a certificate that entitles you to a share of a company’s future profits. The price of a stock is, essentially, an estimate of what a company’s future profits will be, divided by the total amount of shares that exist.
If all that’s going on here is demand shifting, it doesn’t make any sense that stock prices for gun companies would rise by a significant amount. While it’s true that “money today” is better than “money in the future,” interest rates are near zero and time preference doesn’t go nearly far enough to explain why the stocks would rise by so much. Wall Street analysts are very smart people who research stocks in detail and forecast for the long-term. So what’s going on here?
My theory is that Wall Street analysts are approaching this situation with the theory that any new gun control regulations will benefit the large gun companies. This runs contrary to the typical news media coverage of government regulation which stipulates that big business hates regulation and favors small government.
This is completely untrue. Most regulation of industry is lobbied for by the biggest companies in a particular industry. Typically, representatives of the largest companies serve on the regulatory commissions and often literally write the regulations in question. Generally speaking, big companies like regulation because they will control it, and they are so large that it will be easy for them to comply with it. But smaller competitors (and hypothetical future competitors that do not yet exist) will not have such direct involvement in defining the regulations, and the burden that regulations represent will be much more difficult for them to overcome.
This phenomenon is known as “regulatory capture” and is the process by which large companies use the government to help them eliminate competition and make higher profits than they otherwise would have.
My guess is that this is exactly what Wall Street expects to happen regarding gun control regulations. Large players like Smith & Wesson and Ruger will be able to influence gun regulations and will be able to easily adapt to them. But smaller companies will not, and the increased burden of regulation will make the industry less attractive to entrepreneurs, thus discouraging new entrants from competing.
So beware the media narrative that Obama and the big gun companies are bitter enemies, and don’t buy into the incredibly short-sighted analysis that short-term demand shifts leading to sales spikes are influencing stock prices in a major way. Something else is going on here, and it’s the same story we’ve seen again and again throughout history. The government is embarking on a massive scheme that will reduce competition and benefit a few large companies at the expense of everyone else. Rather than heroically resisting the encroaching tyranny of the federal government, the gun companies are hoping to wield government force as a weapon against their competitors. If you think they will succeed, these stocks are probably a good buy. Otherwise, it’s a massive overreaction that will surely spell disaster for investors.