Kids in COLO. Play a Simulated Stock Market Game: Do They Have A Clue?

Kids get into the 'stock market challenge' in Colorado

The "Stock Market Challenge" is a recent invention of Christina Frantz, manager of social responsibility for Great West Financial - a Greenwood Village-based financial services company. The purpose,  as stated in a recent Denver Post piece (Nov. 16, p. 1C),  is to teach kids how the stock market works since "whether they realize it or not most Americans have a stake in the stock market through their retirement programs". Thus, more Americans need "basic financial literacy".

Actually, the 'stake in the stock market' meme needs to be corrected: Americans DO have the choice, for example in their 401ks (most of them anyway),  to select money market or low risk funds as opposed to equities. This is something more might have benefited from if they'd known before the 2008 stock crash. 

The piece goes on to cite a 2013 survey wherein "43 percent said their number one financial worry is not having enough money saved for retirement.".  Another 38 percent fretted about not having enough money to get by according to a Harris Interactive 2013 survey.

But nowhere in the article do readers learn that stock market investment is only one way to attain financial security. A better way  for most average people, perhaps, is to save much more (on average 20-30% more than the average) and instead of plowing it into a volatile market - use it to purchase immediate fixed annuities to ensure a stream of later income. The problem is most Americans would rather risk their stash on the stock market, then have it tied up with an insurance company to provide steady income later. This, to me, is nuts.

Some of the students in the challenge also learned "both the agony and ecstasy the market can offer".  The students initially saw their simulated portfolio growing 26 percent in 30 days- but then "thirty minutes later all the confidence and energy was gone".  They saw $200, 000 "evaporate" in minutes and they ended up near the bottom of the pack. 

The students in this team later said: "It was fun, it was just dream shattering!"

Really, kids? Imagine if that money you lost in minutes was real money and not the synthetic kind!

But most of these students can be forgiven their irrational exuberance given they may not be familiar with certain things going on in the market now. I refer to the recent column by WSJ author Jonathan Clements, who writes that "I find it hard to get enthused  about the prospects for U.S. stocks over the next ten years."

Why?

Clements cites three components of the market's current returns which reflect inflated growth beyond realistic expectations leading to a ridiculously high price to earnings ratio. (He names dividend yield and corporate earnings growth and the value put on those earnings reflected in the P/E ratio.)

He notes,for example, that over the 10 years up to mid-2014, the per share earning of the S&P 500 companies grew 6.3 % a year compared to 3.6% growth in GDP per year. In other words, something is out of kilter -and this anomaly was also warned about by the authors of  'The Great 401k Hoax'. 

The other anomaly is that recent gains have been driven by corporate profit margins. After tax corporate profits rose from 7.9 % of GDP in mid-2004 to 10.6% in early 2014. Without this boost the S&P 500 earnings would have lagged behind GDP. 

The main contributors to this profit anomaly are productivity gains (mainly via automating production or laying off workers and having fewer do the work of those fired) and buying back "as much stock as they've issued". Of course, using these tricks can't go on forever, nor can the Fed's cheap money (quantitative easing) policy.  Besides, that - the more workers laid off or automated the less disposable income they have to purchase the goods and services available- so the path is set for a permanent decline unless: a) more people are hired, and b) at significantly higher wages.

The anomalous S&P increase, combined with the corporate earnings gimmicks, have enabled to P/E ratio to increase to 25.3 since 1990, which might sound great until you compare it to historical averages, i.e. 19.6 over the past 50 years and 16.6 over the past 100 years. This begs the question of what would happen if the current P/E average reverted to its 100 year average, say indicating a drop of 25.3 - 16.6 = 8.7. Well, you might not want to lose sleep thinking about it because it implies a large part of your share value is "phantom money". (Another little item the students in the Stock Market Challenge might have wished to learn about)

This is why Clements ends up pining for a 25 percent correction. In his own words:

"My hope: We get a 25 percent decline in share prices. That would make the market more reasonably valued and provide a buffer against disappointment."

He is right to be concerned as the students would be if their little simulation also included some realistic facts concerning stocks, valuations, capitalization and loss. Say, for example, an original, over-valued stock share plummets after ten years from $50 to 50 cents a share. The market capitalization has now decreased a factor of 100 ($50/ $0.5 = 100) to $5 million. If there are now 10 million investors, the share price can be no more than 50 cents a share and that is the maximal cashout (redemption) amount. Thus if all ten million stock holders cash out at once they will (theoretically) get 50 cents a share. However, since stock managers do demand to take profits, commissions, and don't intend to part with all the money, they use a formula pegged to the volume of selling such that the share value is inversely proportional to the volume.

Thus, what theoretically might look like 50 cents per share on paper, for a mass redemption, will really end up as probably only ten cents per share.

If all the buyers (say of company XYZ stock) initially bought stock at $50 per share, then watched it collapse to $1 a share, where did the money go?  The (Duh!) answer (see also 'Ask Marilyn' column in PARADE, April 5, 2010) is that the sellers (redeemers) got it. Well, who else would? The other aspect is that this scenario only accounts for a tiny fraction of the total money "lost".

Remember that when all the 2 million purchasers of XYZ stock bought it (at $50 per share) they actually artificially inflated the worth of all the shareholders. Obviously, they also inflated the worth-value for all those who bought it at $48, $24, $15 and $1! The reason? Everyone's stock is valued at the last share price times the number of shares owned. Thus, at any time in that transition interim, IF one of those lower purchase owners had the prescience or good fortune to cash out in time, they would have reaped a relative reward. This, despite not having bought the stock at a lower value.

In like manner, Janus World Wide Fund sold shares at one time for as high as $75 each. When I bought in (in 1997) they were still high but not as high as the initial offering rate. As they began a down swing I cashed out (in 1998) at least 100 shares for $70 a share- enough to finance a holiday to Yellowstone National park. Eventually,  the shares crashed to below $30 a share, by which time almost all share holders were selling (which was why the share price was being driven lower).

Consider now that Jack Sprat similarly may be elated at beholding a $174,000 balance after his 10th year of holding XYZ stock,  following an initial investment of $35,000. But he needs to understand that the bulk of this:

$174,000 - $35,000 = $139, 000

is phantom money. (I.e. generated by an excessive P/E ratio)

By the same token, if the following month the share prices collapses back to $5, Jack has not lost $174, 000 but only the money he actually put in up to THAT point, say  $35,250.

It is this larger value, based on a "misleading multiple" of inflated share value times shares, that leads many to believe they have lost money they never owned in the first place. It only appears they did. Such is the stuff of stock hocus pocus which has nearly every modern day "investor" bamboozled and starry -eyed.

What if all sellers sold at once, does that make their losses real? Never in a million years! As I noted earlier, if all sold at once they'd all be victimized since as sellers outnumber buyers the share price drops according to inbuilt formulas used by the companies to correct for diminishing share volume. Diminishing (held) share volume = diminishing returns. Zero sum game anyone? The true and hard fact, again, is that only the prescient or early sellers, are able to obtain the top share price. This is possible because there are many times more "buy and hold" investors to support those sales.

I am pretty certain that none of the kids in the "Stock Market Challenge" were taught any of this!