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Market Basics

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“The bulls and bears go to market where the pigs and sheep are slaughtered.”         –Anonymous

Investors want to get two things: yield, or rent for the money they supply; and growth, or increasing share price for what they own.  In return for these they give up liquidity, for which they expect compensation depending on how long they have to wait to get paid back or how easy it is to convert the loan they make to cash (also known as the time value of money). They should also expect to take on risk roughly in line with the expected return on their invested capital. Consequently, junk bonds with a high risk of default have a high yield to maturity.  The value at which either stocks and bonds trade fluctuates based on how much investors view them as inherently risky AND how much the price today is expected to move in the expected direction (up or down) in the future. Different styles of investors will be long (buying) or short (selling) a given investment based on their strategies and the fact that investors will be betting on either side of a trade is what makes a market. If everyone lines up on one side, either buying or selling, the market ceases to function.

The total capital invested in US company stocks is about $30 trillion. The total outstanding in all forms of debt is around $200 trillion worldwide, of which about $40 trillion is US corporate bonds and government issued bonds and notes.  The total derivatives market is estimated at between $630 trillion and $1.3 quadrillion and mostly big banks play here with money they manufacture out of thin air.   For perspective, the entire cryptocurrency market is under $200 billion.  For regular folks, much of the action is in the bond market and real estate (whether they know it or not).  In any case, the market for stocks in big companies is NOT equivalent to the real economy.

It is vitally important to understand that the price of a bond moves inversely to the yield. A generous discount to maturity means the price paid today is much lower than the promised amount at maturity. This means that a high rate has to be paid to attract investors to what might be a high risk proposition. Most bonds are notes that promise to repay a fixed amount at a given term.  BTW, this is why new cars sticker for a lot when the boobeoisie buy low payments. If the rate is high that means the present value of the investment is lower and will be made up between issuance and maturity by interest.   A low rate means that repayment of principle is considered more like a sure thing so the amount to buy the bond at issue will be much closer to the amount at maturity. US Treasuries and bonds with certain income streams or taxing authorities behind them are generally like this. However, the price paid today is also subject to market factors that may be independent of the price the issuer has to pay the bearer at maturity. Only a small fraction of bonds are held by a single buyer from issuance to maturity.  Buyers and sellers are disagreeing over what the actual price of the bond should be all along the way and they create upward or downward pressure on the yield.

Adjusted for inflation, the S&P 500 have returned on average about 7% per year for the last 90 years.  Depending on when you start and stop the clock, the return might have been negative or much higher.  This is especially problematic if you are near retirement and the stock market is at an historic high having broken records for length and extent of a bull run. While past performance is, as they say, no guarantee of future success, it is frequently all you have to go on unless you dig into fundamentals that should be driving future value.

Since the famous Greenspan put of the 1990’s, but especially since the Bernanke free money extravaganza beginning in 2008, growth investors have dominated and the stock market has mostly gone up.  Stock investor strategy has been ‘buy the friggin’ dip’ for so long we have a generation of investors who think buying based on fundamentals is simply foolish.  Only momentum matters to them and that’s why they are sometimes called “momos.”    The reason this has been possible is because the Federal Reserve and Treasury have kept rates artificially low which has caused companies to issue massive amounts of debt to buy back shares in their companies to drive up the stock price, for which the top executives are well rewarded.  The debt that companies have issued has also been sold to yield hungry investors. The lofty prices of stocks are due to a kind of market manipulation that previous generations would have viewed as lunacy. The market capitalization of the stock market therefore has very little to do with creating value or “disrupting,” or anything like that. It’s mostly about a few rich people & The Federal Reserve loading up balance sheets with funny money to get big bonuses.  This is not political opinion, it’s just math and you can check it yourself.   At the same time, this moral hazard supported by the Fed and Treasury punishes savers and those who are responsible with credit in favor of speculators and the top echelon of managers. Again, this is not an opinion, these data are readily available.

Keep in mind that if a company goes out of business the shares can be worth zero and creditors may or may not have claims that are honored.  Many large companies are called zombies today because they have share prices that have little or nothing to do with their expected earnings or debt load.  They burn cash and make no profit and may not make a profit ever but the market bids them up anyway.  Value investors think it’s wacky to own shares in a company like this. Growth investors think it’s crazy not to. Given the change in share price over the last several years, the “empirical data” seems to favor the growth investors.  Whether you are inclined towards either camp you can’t help but take a risk. Either you will forego growth for the sake of honest price discovery and fundamental value, or you will continue to buy what everyone is buying and watch the pile grow, hoping you can get out before the rush to the exits that you may think will never happen.

Lots of folks have gained some paper wealth in their retirement plans and the run-up in home prices. None of these gains are realized until they sell. Most of the equity that is not controlled by institutions is with baby boomers, who are already in or are approaching draw-down because they have aged out of the work force.  What is left to them or their heirs after paying for elder care, their own health and living costs and education for their under-producing and over leveraged kids is going to be a big hole of a sell order.   The country could have spent the last 20 years preparing for this and helping younger people take their place but it went on a borrowing binge instead.  This can’t end well.

So let’s get back to the micro view particulars.  If you have been saving a lot and increasing earnings but not expenses and have 10 or more years to go until you can’t earn anything like what you do now, you have a shot at financial security, but only if you take control, do your homework and invest to beat the herd.  Can you do this? Yes, but not if you don’t practice and not if you waste time and money on pipe dreams, guaranteed-to-fail start-ups, network marketing schemes and lotto tickets.  You also need to out-exploit the exploiters when it comes to income and savings.  Or you could just vote for free stuff for all but you need to understand that you are the one holding the bag for everyone else.  The monsters on top of the pyramid will make sure of that.

By vitruvius1

Andrew Talbot

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