Bringing The Stock Market Back In Synch With Main Street: It CAN Be Done But A Price Will Be Paid

 "The stock market isn’t the economy: more than half of all stocks are owned by only 1 percent of Americans, while the bottom half of the population owns only 0.7 percent of the market." - Paul Krugman, NY Times, 'The Recovery Is Bypassing Those Who Need It Most', Monday

The stock market is in a bubble of historic proportions (Financial Times Tuesday, 'U.S. Stock Bubble Ranks Among Biggest in History') and needs to be punctured.  It is time this misbegotten financial anomaly be brought back down to earth.  The nonstop headlines appearing on the financial pages of how the stock market exchanges (DOW, NASDAQ, S&P 500) keep defying economic gravity while Main Street suffers are exhausted.  As I  explained in my Aug. 18th post part of the reason for the disconnect can be traced to the Vix volatility index,  which is Wall Street's  "fear gauge".  It is a barometer of how unstable stocks are in responding to current crises or shocks.    

Another measure is called the Economic VIX Index, created by Jim Paulsen, a chief investment strategist at Leuthold Group. This index reflects the volatility  in growth.   It's important now because its history over the decades since World War II shows two things:

1) Stocks do best when economic volatility in the U.S. is at its lowest.

2) Stocks do best when economic volatility in the U.S. is at its highest.

The current crisis driving response from one day to the next is the pandemic which also drives volatility : Will a vaccine soon be available so the economy can get back to normal?  Will a good, effective treatment be available, if not what other options are there?  Will  a  second or third wave hit us?   Since the answers may vary one day to the next then the Economic  VIX is also likely to vary, even whipsaw as different voices give different accounts even on the same day.  But why would stocks continue to do well - despite Main Street's woes-- even in an atmosphere of upheaval.  According to Paulsen:

"This is because the economy is in an unsustainable situation and everyone is working to improve it, both government and companies.  So policy officials are scared to death and they are bringing every conceivable tool they have to get us out of the situation."

But again, this is also based on an expectation: that there is constant and continued positive response to containing the virus.  Also, in the case of the roaring tech stocks that they "remain the clear winner of the coronavirus pandemic."  (WSJ,  Sept. 5-6, p. B1).  Why is this?  Because (ibid.):

"Although the virus upended most businesses, big technology companies have weathered the crisis as people relied on apps and software to work, stream movies and communicate with friends and family"

But there is also a darker, more cynical aspect at work (e.g. WSJ, p. B3, Sept.5-6):

"The shift to  remote work over the past few months - in some cases marking a permanent change-  has refocused the sights of many corporate and private equity buyers to acquisitions that help build new capabilities."

Among the latter 'capabilities' is the startling potential to dispense with millions more human workers altogether.  Why keep them if the same amount of work can be done in  remote venues and  by fewer techies?   This understated element is also clearly what's driving the tech binge.

Indeed, in a recent essay, David Autor - an MIT economist-  and Elizabeth Reynolds (head of the Task Force in the Work of the Future at MIT) outlined the ways they believe technology -driven trends unique to the pandemic will continue to disrupt the lives of some of the nation's most vulnerable workers.   One cited is "telepresence", i.e. by forcing so many professionals to work remotely all at once the pandemic may have permanently reduced how often people work from an office and indeed how many in the future are even hired to work from offices.

This is still hard to reconcile with the desperate plight of America’s 24m  jobless, a crisis that’s approached the unthinkable levels of the Great Depression of the 1930s.  But incredibly, that still isn’t the biggest story on the news cycle. It is rather the continuing social unrest and protests, even violent reactions like Right wing terrorists firing their weapons or pepper spray at innocent protesters.  In terms of perspective the latter is 'small cheese' compared to the economy cratering.  As blogger Will Bunch put it in a past weekend post on smirkingchimp.com:

"Seriously? You’re worried about social unrest now? Just imagine the chaos in a few months, when homeless people sleep on park benches under a blanket of newspaper headlines ...."

But what about the newly announced "moratorium" on evictions? More smoke and mirrors.  True, the government issued a new eviction moratorium last week.  But here's the rub: it is without funding for rental assistance.  Hence, tenants unable to cover rent will face a massive balloon payment or eviction at the end of the year.   Unable to cough up $1,100 rent now?  How about $4,400 in December? This hardly gives them new financial breathing space.

This leaves the matter of bringing the stock market more in line with the reality of  a struggling Main Street economy, and that in turn means puncturing the bubble. As the FT's Andrew Parlin points out, that there is a bubble is beyond contention given some tech stocks are trading at 50 times earnings. (P/E ratio.)  As he writes (ibid.):

"Bubbles are formed around individual stocks and sectors. As the concentric circles of excess widen, more and more stocks are infected.  Wildly exaggerated stock stories force a delinking between fundamental analysis and stock prices."

And he adds as a warning (ibid.):

"This gets at the troubling thing about bubbles. They do not simply undergo smooth and endogenous shrinkage until they disappear. Instead, they continue to expand until they burst."

Who are the people actually partaking of this stock bubble?  Mostly the richest Americans who have the disposable income to make bets in the Maul Street casino, and they are from 1 to 2 percent of the populace.  According to Edward Wolff, an economics professor from New York University (quoted last week in the WSJ, 'Stock Gains Go To Fewer People Now'):

"The middle class has essentially been left out of the stock market surge. The rich have taken off from the rest of society."

In other words, a tiny element of the investor class are racking up huge profits from an abnormal market that is skewed toward technology. (As the FT reports,  5 tech companies account for a fourth of the value of the entire S&P 500). One which ultimately may be responsible for even greater income inequality.   But given the small participation fraction, one can feel better if and when this bubble bursts.  Which will even things out in terms of aggregate demand and bring the market more in tune with Main Street.

How to expedite this?

The first and most obvious way to do this is to raise the interest rate - thereby making the "crack" (money) on which the market feeds more expensive.  Right now investment money is so cheap, so low cost that any amount of leverage is possible.  Why worry too much about paying the piper back with interest rates next to zero?  As Will Bunch has observed in his most recent blog post:  

"We’ve created a system that can pump in literally trillions of dollars to prop up stocks — led by a Federal Reserve whose chairman was appointed by a president who uses the sky-high Dow to argue for his re-election — but gridlocks over the idea of helping families pay their $500 monthly rent."

Raise the interest rate, say to 2.5 - 3.5 % and watch the stock balloon burst and a modicum of realism return - and sanity.   At that point we - the savers (who rely on bank interest rates for savings accounts, not risky equities or 'munis') will enjoy getting some decent return for once.  At the same time we will be elated to see the parasites who profit from the cheap money -  driven by low interest rates -  return to ground level.

But this is only one side of the coin, taxes also need to be raised- locally and by state governments- if not federally. (Unlike most states the federal gov't does not have to balance its budget every year, so it could solve the problem tomorrow by providing fiscal relief to states and localities, like the $1 trillion provided by the HEROES Act that passed the House in May.)

Regardless of whether the Repuke Senate acts or follows the McConnell approach of letting states pound sand, states and localities can bolster their local economies by raising taxes on those who have not been hard hit by the recession. This is not only the right thing to do from a humanitarian standpoint, it is sound economics.  Don't believe me?  Consult the terrific monograph: The Indebted Society  (1995), by James Medoff and Andrew Harless, wherein they found, p. 87:

"High tax rates are associated with higher productivity growth. There is a consistent and strong relationship.". 

This was written barely a year into Bill Clinton's imposition of a marginally higher tax rate on the wealthiest, and we saw after the fact more than 20 million jobs created, even as the deficits decreased and a healthy ($600m) surplus was left for Bush Jr.

In the present situation we need tax hikes as opposed to tax cuts which latter will trigger devastating spending cuts by virtue of insufficient revenue. Such spending cuts are enormously harmful to the people who rely on government services as well as the public workers who would lose their jobs. In a recession, such cuts also course through and damage the broader economy, causing layoffs to ripple through the community.  

These layoffs adversely affect spending on goods and services, so negatively impact aggregate demand.  Aggregate demand is composed of two parts: 1) demand generated by consumers for goods and services, and 2) the demand for investment goods. When the level of aggregate demand is high, both these components are generally equally high, and the levels of production and employment are high. On the other hand, when aggregate demand is low - or even one of the components (e.g. (1)) is very  low, then levels of production  plummet.

So when you fire a teacher, for example, you not only harm her family. You also create a chain reaction, harming the local grocery where she shops, and all the other people and businesses she gives money to.

Doing the math - using even conservative estimates-  one finds that each dollar of spending cuts translates to a drop of at least $1.50 in the gross domestic product.  (There are reasons to believe that the drop is as much as $2.50.) With state budget shortfalls forecast to approach $300 billion this fiscal year, a spending-cut-only approach to balancing state budgets will cause at least a $450 billion reduction in G.D.P.— more than 2 percent.  

One complaint about adopting tax increases is: 'We can't afford to do that right now!'.  But that's false. While it is true tens of millions have lost their jobs, almost half of Americans report that their household has not lost any employment income at all, according to Census Bureau data. That figure jumps to two-thirds for households bringing home more than $200,000 per year.  All of these households can be taxed for the greater good, so states and localities don't have to go on a"Hannibal Lecter"- style economic slashing fest.

Thus tax increases, especially on these high-income people  in the stock market (who aren’t living paycheck to paycheck), are much less economically damaging, costing the economy only around 35 cents for every dollar raised. States and localities that raise taxes on the rich to increase spending will create at least $1.15 of economic activity for every dollar raised, and most likely closer to $2.15 or more.  

The beauty of this higher tax approach, especially in concert with a Federal Reserve (much) higher interest approach, is that it will bring the financial system and Main Street economy more into balance. The 1 percent or so now making out like bandits in the stock market (because savers are basically subsidizing them) will now be out of luck. Meanwhile, the 97- 98 % not in the markets will finally see some financial relief.  Or should!

See  Also:

Economic Policy | Jobs | Wall Street

The Real 'Hoax' in America Is Record Wall Street Profits as Nation's Jobless Millions Cannot Afford Rent

And:

Economic Policy | Wall Street

Indecent Stock Market Boom Exposes Riot-inducing Inequality, Not Economic Positives

The Perils Of Remaining In An Overheated Stock Market

As the DOW passed the magic  22,000 mark,  millions of stock investors began salivating at the prospect of  continued humongous gains - filling their 401ks or IRAs.  But most are barely aware of the treacherous territory they've entered.  Most had never  seen or read Nate Silver's book, The Signal and the Noise- Why So Many Predictions Fail But Some Don’t  - especially where he warned (p. 347):

"Of the eight times in which the S&P 500 has increased at a rate much faster than its historical average over a 5-year period , five cases were followed by a severe and notorious crash, such as the Great Depression and the Black Monday crash of 1987”.

Interestingly, two of the largest stock market dives have followed two of the biggest bubbles: the first of 37.85 percent and on the heels of the bubble that formed from Jan. 14, 2000 to Oct. 9, 2002, and the second of 58.78 percent that formed (mainly due to the housing bubble) from Oct. 9, 2007 to March 9, 2009.

One indicator of a bubble, of course, is the rate of stock  share increase. But another is the rate of inflation related to the trailing P/E ratio.  This is the classic price to earnings which looks at the current price divided by the company's total earnings the past 12 months. .  This is perhaps the most common metric used by investors to value publicly traded companies. While it does not account for growth rates by default, it represents a simple metric that can be compared over long periods of time. Lofty P/E multiples can predict market declines when growth starts to slow down, since investors can no longer justify the higher valuations.

Well, we are in that territory now. For reference, three years ago (in September)  the P/E ratio was about 18.5. Today the P/E for stock in the S& P 500 index is just over 24.  That is, investors are paying $24 for each $1 in corporate earnings. Just before the 2008 crash and 2009 financial meltdown it hit 27.   

What about those profits? Back in September, 2014, the profits for all the companies in the S & P 500 index were about $106 a share.  Currently, we're in the midst of second quarter earnings reports for 2017 and the estimate is that the same S & P 500 profits will be coming in at about $105 a share. That means profits haven't grown at all in three years - and yet the price of the S & P 500 is up about 23 % over the same period.

What gives?   What gives is that there is no genuine support for the share increases or higher PE ratio.  In other words, people are basically being hosed. Let's also note the long term average pE ratio is about 16 and markets tend to revert to that average at some point.

The other aspect is there is no really solid backing to justify the spiking DOW or sizzling S & P 500. The corporate earnings, profits simply don't support it. This is also why there exists a divergence between what we ae seeing with the stock market, and the low growth and wage stagnation plaguing Main Street.

But we were warned of this before. As the authors (William Wolman, Anne Colamosca)  of The Great 401 k Hoax have noted, it is living in a fool's paradise to believe that if the companies you invested in are only increasing their profits at 2-3% a year, that you can be earning 7% or even 10%. In fact, what one has then is an aberration in which the gains are out of whack with reality. (This is one reason why real stock investors demand dividends, and refuse to forego them so fund companies etc. can use the money to do "stock buybacks" thereby artificially inflating the share price!)

Why is this perilous? Some might ask. Consider: though you may be exuberant now to be getting near 10 percent returns, what if the market suddenly reverts back to the more standard 7 percent?  Doing the math it means you would need to save 70 percent more money to get to the same place as you have with the 10 percent returns.   Translated to income saved to pay for mutual funds or stocks, this means if you are taking out 5 percent now - say $150 a month - you will need to shell out $255 in the 7 percent return environment.  Obviously, if the returns go even lower - say to 5 percent or less- the savings burden will increase as well.

Simply put, the notion that you can save less because the market will do most of the heavy lifting is a fool's errand and paradigm. It won't. In fact, you will be in a hell of a lot worse position if the market tanks - say in a 20 percent correction. To get down to even more severe (e.g. crash) cases, a stock – or mutual fund- that drops in share price from $20 to $10 has suffered a 50% loss. But for that $10 stock or fund share price to return to $20  (breakeven point) it must gain 100%, or double.  Those near retirement need to ask themselves if they can sustain such a loss, and to multiple stocks or funds.

The other phantom contributing to the inflated PE ratio accompanied by low corporate profits, is stock buybacks which I've written about before.  The question every investor ought to ask is: WHY should Company X or Y have to buy back its own stock to create an artificial rise in share price if your company is genuinely doing well? It makes no sense. If Company X or Y is going to use any extra money for anything it ought to be for paying dividends, not stock buybacks!

Columnist Jonathan Clements in his piece in the WSJ three years ago wrote:

"Many companies were big buyers of their own stock before the 2007-09 market decline, only to scuttle their buyback programs during the market crash. In recent years with share prices up sharply they have begun to voraciously buy back."

And indeed they are doing it now more than ever.  Why not, because they are then reaping the bounty of their own high share prices? Buy backs also make management's stock options more valuable - so what better way to compensate the Street's honchos?  Strangely, all this has selectively blinded investors to the lack of dividends. As Robert Arnott, quoted by Clements, stated:

"Dividends are reliable, You cut them at your own peril - but you can cut a buyback and hardly anyone notices."

There's one more reason U.S. stocks are soaring which people ought to be aware of: According to the WSJ European investors are buying them up at a rate 25- 30 % greater than historical averages. You may cheer that our friends across the pond are helping us to this extent, but wait. What if they suddenly pull their money out, redeem all those shares, for whatever reason? 

It's time to think now more carefully than ever just where you're putting your money and why.

An Aging Bull Market Headed For The Dumpster - Are You Ready?

A subset of the 23 Bull Markets and their durations in days. The longer the Bull Market the closer it gets to its expiration date.

Jason Zweig, he of the "Intelligent Investor" column of The Wall Street Journal, had some excellent advice for those still in the stock market: buckle up and hold on. Zweig begins by asking if people recall that between October, 2007 and March, 2009, the U.S. stock market dropped in price by 57 percent. It was a time of angst as 401ks were wiped out left and right and victims had to either notch down their retirement plans, or plan for longer working years.

Zweig then adds, with little consolation:

"If you think stocks can't fall by at least 50 percent again you are wrong. ...And if you think you won't over react when it does you had better test that belief now before it's too late to find out you were kidding yourself".


This isn't just blowing smoke or sparking reckless jitters. Anyone who knows anything about markets knows the existing Bull is already breeding a monster asset bubble just right for the bursting. And let's not forget it was George P. Brockway in his 'End of Economic Man' who noted that all Bull markets end and most do it in spectacular crash fashion with ordinary investors the ones most often left without the shirts on their backs. The more inflated the asset bubble underling the Bull, in this case fed by QE 'crack', the bigger the crash. Nate Silver in fact already pointed out two years ago how this one is in dangerous territory given the 21 % increase at that time.

Now, new research, based on Bull lifetimes, shows they can be seen in terms of comparative human life spans. And we know the older a human gets the closer he is to croaking time.  According to Michael Ball of Weatherstone Capital Management (Denver Post Business, Aug. 12,  p. 13A), the current bull market run (in days) is equivalent to an 88.3 year old person.  Let's face it, that's pretty close to 'kick the bucket' time.

As he put it (ibid.):

"We are very late into a normal bull market life span. Problems will come up sooner rather than later."

As may be seen from the attached graphic, this bull market at 2,262 days already ranks as the fourth longest in modern history.  By comparison, the bull that led to the stock market crash of 1929 lasted for 2,932 days (equal to 94.4 human years). On the more encouraging side, that bull saw a 497 percent gain in 8 years, while the current one has seen a 180 percent gain in 6 years. Maybe, indeed, we should hope for a correction soon - which could come as soon as the first Fed interest rate increase.

But other factors are also weighing on the stock market including slowing global growth, declining corporate  earnings and rising bond yields.  Stock valuations, as gauge by the P/E or price to earnings ratio are also way too "rich", having already crossed into the top 10 percent of bulls.

Who are the most likely to 'take a bath' when crunch time hits? Ball points out a certain subset of baby boomers who haven't been content with the low yields from pedestrian savings instruments like money market funds and have exposed themselves much more in risky equities. Of course, indexed funds (like those of Vanguard) are always a safer bet than managed funds, but in a major correction or crash of 50 percent or more, no one's money will be safe.  If you have a half mil tied up in the markets can you afford to lose $250,000?

Ball also notes that those investors who've already been mauled by two bear markets in 15 years won't easily be able to wait out this bull to see if it turns into a bear. They may have to redeem early, take their money and run as it were. Probably a better choice than having to eat cat food and kibbles the rest of your days.

Ball's final parting words for anyone who wants to hear them?

"It's a prudent time to take some money out of stocks."

Amen.

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!

Do Mom & Pop Really Belong in the Stock Market?

As the continued volatility in the stock market gets more attention, and many oldsters saving for retirement have already lost nearly 40% in their 401ks, the question arises: Do ordinary small fry, whose only money is being saved from nearly stagnant wages, belong in the stock market?

Of course, the endless parade of gurus and pundits of high finance (e.g. Jim Cramer of 'Mad Money' fame on CNBC, until a couple weeks ago) have always issued the same mantra: Just invest and "dollar cost averaging will take care of the rest". When the stocks and whatnot tank and you buy on the dips, you get more shares! What's not to love?

Actually a lot! As the authors of The Great 401 k Hoax have noted, it is living in a fool's paradise to believe that if the companies you invested in are only increasing their profits at 2-3% a year, that you can be earning 7% or even 10%. In fact, what one has then is an aberration in which the gains are out of whack with reality. (This is one reason why real stock investors demand dividends, and refuse to forego them so fund companies etc. can use the money to do "stock buybacks" thereby artificially inflating the share price!)

Further, a Stanford University study some years ago- based on the median return of 62 mutual funds- showed that $1 invested in 1962 would have grown to $21.89 by 1992, on a pre-tax basis. The study disclosed that the $1 would have grown to only $9.87 on an after-tax basis. And the investor would have had to come up with $12.02 to pay the taxes.

By contrast the study showed that a “conservative” investor who put assets into a U.S. Savings Bond in 1962, had every $1 become $10.93 by 1992. It is easy to work out from these numbers which investor actually fared better over the thirty-year interval according to the study. Hint- hint: it wasn't the sucker in stocks.

Unless mutuals investors do the math and watch the numbers they cannot be aware of how little they're actually taking home. (A point also made emphatically in The Wall Street Journal, Nov. 27, 2003, page D1, 'A Harsh Truth: Most of Your Investments Won't Make Money- Even in the Long Term, after assessing stocks, bonds and mutuals).

It is also well for small investors to understand that, to a large degree, they are in a game with a 'stacked deck'. Not only that, but under current laws their investments are almost entirely blind. Like buying a pig in a poke.

This point was emphasized in a London Financial Times article (‘A Metaphorical Proposal’, Mar. 13, 2002, p. 11A) by Michael Skapinker. He cited remarks by Joseph Berardino – chief exec of Arthur Andersen- who noted how the current reporting system “fails to communicate essential information about the real risks facing companies” to the small investor.

If you don't KNOW what you're getting into, how the hell can you have any confidence that you will get anything back? You can't!

Skapinker quotes Berardino as noting how accountants can only issue ‘pass’ or ‘fail’ judgments on companies – but cannot disclose the red ink being bled by a company that’s been passed. (What's referred to as a “bleeding edge” company wherein auditors are actually resigning). As the author notes, to do so would precipitate a collapse in share prices.

Under such conditions, the small investor risks his money and security, by investing in ANY non-FDIC insured monetary device. Indeed, despite the bevy of risks and deceptions, some investors have been insane enough to take out 2nd mortgages to up the ante in the stock market, yet don't even know the role of NAV (Net Asset Value) in calculating net gains, losses.

In fact, the stock market's sole purpose, As E. Brockway observes (The End of Economic Man, 1990), is to steal capital from the poor or middle class (that can least afford losses) and give it to the rich. The technique hardly varies: Pundits, wags and paid shills hype the various stocks, funds or instigate a "buzz" about them - to get suckers to buy in.

The increasing buy-in inflates the price-to -earnings ratio (P-E ratio) and produces a bubble of high profits. The "Big boys" (large, institutional investors) get tipped 1-2 days in advance and cash out, leaving the little guys to sink. If they're lucky they may earn a few bucks. Not much.

The thievery works eventually because most manjacks are conditioned to "buy and hold" rather than fold when the share price dives below a certain threshold. (Which ought to be the tip off). Thus, there are always ample marks left at the end game to be properly fleeced. Amazingly, they're always ready to play the game again, and pile their newly saved up money in.

Lastly, NO American of any class or station (except possibly the super-rich that can afford stupid or reckless losses) has any business putting money into any investments at all unless s/he can pass with at least a 75% a basic investment test. My own version - developed by myself and a financial advisor brother - includes the following questions (no googling, crib notes or texts!):

1) What is a P/E ratio?

2) What is the maximum tolerable expense ratio, beyond which an investor shouldn’t invest in a mutual fund?

3)Distinguish between front and back loads.

4) Joe has $10,000 to invest and the fund is front loaded at 5%. How much is he really investing? How much must he gain the first year to reach break-even? How much must his fund earn to achieve a REAL 5% gain. (Assume the expense ratio is 2%)

5) Distinguish between bonds and bond funds?


6) How would you recognize collateral debt obligations (CDOs) in a bond fund? Interest only strips? Inverse floaters?

7) When investing in stocks, one of the worst tricks used by brokers or managers is collusion using ‘micro caps’ to keep their clients buying and selling stocks within a closed artificial market. (Source:License To Steal: The Secret World of Wall Street Brokers and the Systematic Plundering of the American Investor, page 211). Explain.

8) Small, individual investors in stocks are usually fleeced by brokers through “crossing”, “churning” and “parking”. Explain in turn how each of these would work.

9) WHY is the ADV form Part II essential before hiring a financial advisor? What key information therein would provide a sound basis for rejecting any FA?

10) Distinguish between money market accounts and money market funds. Why are the latter always riskier?

I seriously doubt 9 out of 10 middle or lower income Americans (particularly seniors putting their hopes in the market for retirement) could answer as many as five of the above correctly. And assuming that is so, its' a damned good thing "only 17 percent of households in the bottom 60 percent of income own any taxable stock."

If stocks aren't the answer, what are? Slow and unsexy saving! Then, take that savings by age 65 (say maybe $300,000) and parcel it into separate immediate fixed annuities to provide a safe, dependable income stream over your lifetime, as opposed to a variable money stream - based on the phantom money in the stock market.

As finance columnist Humberto Cruz has complained - and I do now- for some incomprehensible reason Americans would rather play the stock casino than go with dependable immediate fixed annuities. (Variables are not even on the table, as Suze Ormond has noted, they are "stupid" and a waste of time, as per her MONEY magazine interview). Combined with Social Security, a set of immediate fixed annuities is the sane and sensible answer to funding retirement today.

You certainly won't be rich, but then you won't have to sustain a diet of Alpo and Ramen noodles either, or work until your drop dead in your few years remaining on the planet!