Why the Stock Market is so Good when the Economy is so Bad

Posted by PITHOCRATES - March 31st, 2014

Economics 101

No One is going to get Rich by Buying and Selling only one Share of Stock

It takes money to make money.  I’m sure we all heard that before.  If you want to ‘flip’ a house you need money for a down payment to get a mortgage first.  If you want to start a business you need to save up some money first.  Or borrow it from a family member.  And if you want to get rich by playing the stock market you need money.  A lot of money.  Because you only make money by selling stocks.  And before you can sell them you have to buy them.

Stock prices may go up and down a lot.  But over a period of time the average stock price may only increase a little bit.  So if you bought one share of stock at, say, $35 and sold it later at, say, $37.50 that’s a gain of 7.14%.  Which is pretty impressive.  Just try to earn that with a savings account at a bank.  Of course, you only made a whopping $2.50.  So no one is going to get rich by buying and selling only one share of stock.

However, if you bought 10,000 shares of a stock at $35/share and then sold it later at $37.50 that’s a whole other story.  Your initial stock purchase will cost you $350,000.  And that stock will sell for $375,000 at $37.50/share.  Giving you a gain of $25,000.  Let’s say you make 6 buys and sells in a year like this with the same money.  You buy some stock, hold it a month or so and then sell it.  Then you use that money to buy some more stock, hold it for a month or so and then sell it.  Assuming you replicate the same 7.14% stock gain through all of these transactions the total gain will come to $150,000.  And if you used no more than your original investment of $350,000 during that year that $350,000 will have given you a return on investment of 42.9%.  This is why the rich get richer.  Because they have the money to make money.  Of course, if stock prices move the other way investors can have losses as big as these gains.

Rich Investors benefit most from the Fed’s Quantitative Easing that gives us Near-Zero Interest Rates

Rich investors can make an even higher return on investment by borrowing from a brokerage house.  He or she can open a margin account.  Deposit something of value in it (money, stocks, option, etc.) and use that value as collateral.  This isn’t exactly how it works but it will serve as an illustration.  In our example an investor could open a margin account with a value of $175,000.  So instead of spending $350,000 the investor can borrow $175,000 from the broker and add it to his or her $175,000.  Bringing the total stock investment to $350,000.  Earning that $25,000 by risking half of the previous amount.  Bringing the return on investment to 116.7%.  But these big returns come with even bigger risks.  For if your stock loses value it can make your losses as big as those gains.

Some investors borrow money entirely to make money.  Such as carry trades.  Where an investor will borrow a currency from a low-interest rate country to invest in the currency of a higher-interest rate country.  For example, they could borrow a foreign currency at a near zero interest rate (like the Japanese yen).  Convert that money into U.S. dollars.  And then use that money to buy an American treasury bond paying, say, 2%.  So they basically borrow money for free to invest.  Making a return on investment without using any of his or her money.  However, these carry trades can be very risky.  For if the yen gains value against the U.S. dollar the investor will have to pay back more yen than they borrowed.  Wiping out any gain they made.  Perhaps even turning that gain into a loss.  And a small swing in the exchange rate can create a huge loss.

So there is big money to make in the stock market.  Making money with money.  And investors can make even more money when they borrow money.  Making money with other people’s money.  Something rich investors like doing.  Something rich investors can do because they are rich.  For having money means you don’t have to use your money to make money.  Because having money gives you collateral.  The ability to use other people’s money.  At very attractive interest rates.  In fact, it’s these rich investors that benefit most from the Fed’s quantitative easing that is giving us near-zero interest rates.

People on Wall Street are having the Time of their Lives during the Obama Administration

We are in the worst economic recovery since that following the Great Depression.  Yet the stock market is doing very well.  Investors are making a lot of money.  At a time when businesses are not hiring.  The labor force participation rate has fallen to levels not seen since the Seventies.  People can’t find full-time jobs.  Some are working a part-time job because that’s all they can find.  Some are working 2 part-time jobs.  Or more.  Others have just given up trying to find a full-time job.  People the Bureau of Labor Statistics (BLS) no longer counts when calculating the unemployment rate.

This is the only reason why the unemployment rate has fallen.  If you add the number of people who have left the labor force since President Obama took office to the number the BLS reports as unemployed it would bring the unemployment rate up to 13.7% ((10,459,000 + 10,854,000)/155,724,000) at the end of February.  So the economy is still horrible.  No secret to those struggling in it.  And the median family who has seen their income fall.  So why is the stock market doing so well when businesses are not?  When profitable businesses operations typically drive the stock market?  For when businesses do well they grow and hire more people.  But businesses aren’t growing and hiring more people.  So if it’s not profitable businesses operations raising stock prices what is?  Just how are the rich getting richer when the economy as a whole is stuck in the worst economic recovery since that following the Great Depression?

Because of near zero interest rates.  The Fed has lowered interest rates to near zero to purportedly stimulate the economy.  Which it hasn’t.  When they could lower interest rates no more they started their quantitative easing.  Printing money to buy bonds on the open market.  Flooding the economy with cheap money.  But people aren’t borrowing it.  Because the employment picture is so poor that they just aren’t spending money.  Either because they don’t have a job.  Only have a part time job.  Or are terrified they may lose their job.  And if they do lose their job the last thing they want when unemployed is a lot of debt they can’t service.  And then there’s Obamacare.  Forcing people to buy costly insurance.  Leaving them less to spend on other things.  And increasing the cost of doing business.  Another reason not to hire people.

So the economy is going nowhere.  And because of the bad economy businesses have no intentions of spending or expanding.  So they don’t need any of that cheap money.  So where is it going?  Wall Street.  The only people who are borrowing and spending money.  They’re taking that super cheap money and they’re using it to buy and sell stocks.  They’re buying and selling like never before.  Making huge profits.  Thanks to other people’s money.  This is what is raising stock prices.  Not profitable businesses operations.  But investors bidding up stock prices with borrowed money.  The people on Wall Street are having the time of their lives during the Obama administration.  Because the Obama administration’s policies favor the rich on Wall Street.  Whose only worry these days is if the Fed stops printing money.  Which will raise interest rates.  And end the drunken orgy on Wall Street.  Which is why whenever it appears the Fed will taper (i.e., print less money each month) their quantitative easing because the economy is ‘showing signs of improvement’ investors panic and start selling.  In a rush to lock in their earnings before the stock prices they inflated come crashing down to reality.  For without that ‘free’ money from the Fed the orgy of buying will come to an end.  And no one wants to be the one holding on to those inflated stocks when the bubble bursts.  When there will be no more buyers.  At least, when there will be no more buyers willing to buy at those inflated stock prices.  Which is why investors today hate good economic news.  For there is nothing worse for an investor in the Obama economy than a good economy.

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Planters, Money, Factors, Risk, Interest, Discounting, Accounts Receivable and Accounts Receivable Factoring

Posted by PITHOCRATES - November 27th, 2012

History 101

When a Factor advanced their Money to a Planter it could take up to 9 Months or more to Get it Back

It takes money to make money.  And in the early days before big banks there were few places to get big amounts of money.  Which you needed in the New World to grow large crops like tobacco.  You needed big amounts of money because it took a long time from planting a crop to getting it to market in Europe.  Planters needed money to plant, grow, harvest, bale, ship to a seaport where it then shipped by sail to a European market.  Then money from the eventual sale of that tobacco would take a couple of months to make it back to the planter.

It could take up to 9 months or more before they actually got the proceeds from the crops they grew.  And there were no large banks to provide financing for the planters.  So what did they do?  Enter rich people.  And merchant banks.  Factors.  Who advanced planters money to plant, grow, harvest, bale and ship their crops to a European market.  And when they sold those crops and the money worked its way back across the ocean it went to the factors.

But why would rich people do this?  Why would they take a risk with their money?  When they advanced their money it could take up to 9 months or more before they got it back.  A lot could happen in 9 months.  A drought could have wiped out their crop.  Insect infestation could have eaten their crop.  Fire could have destroyed the crop as it made its way to an ocean going sailing ship.  And that sailing ship could have suffered damage in a storm and sank.  So there was a lot of risk these rich people took.  So why did they?

Factors bought a Future Crop at a Discount from what they Expected it would Sell For

Well, they could mitigate some of this risk by purchasing marine insurance.  To cover the cost of their cargo in the event it was lost at sea.  But insurance policies aren’t free.  They cost money, too.  Not to mention the shipping costs to get these crops to market.  Costs that had to come out of those crops.  So there are costs.  And some work.  Back then you didn’t buy insurance or pay for transportation electronically.  People went to places and negotiated these things with other people.  People who earned wages and didn’t work for free.

Today when someone borrows large sums of money they pay interest.  Which helps to offset any costs incurred.  And let’s people earn money by loaning money.  Which provides an incentive to loan money.  Which is the only way people can borrow money.  When people are willing to loan it.  And people only loan money when it’s worth their while.  People save their money in the bank to earn interest.  They don’t put it there so others can borrow it for free.  But before large banks they needed another way to get money to people who needed it.  Which brings us back to those factors.

Factors made their money by discounting.  Which is a way of earning interest without charging interest.  When you buy a Treasury bill you are acting like a factor.  You may pay $970 dollars for a Treasury bill with a face value of $1,000.  When you redeem this Treasury bill the government pays you $1,000.  Giving you a $30 financial gain.  Which works out to an effective interest rate of 3%.  People like buying treasury securities because they are backed by the full faith and credit of the United States.  So there is little risk.  Whereas factors took a huge risk.  So they didn’t do it on any promise to pay.  They got collateral.  They bought a future crop at a discount from what they expected it would sell for.  Which became theirs.  And when that crop sold they got all the proceeds from that sale.  Hopefully they got as much as they thought it would sell for.  Or more.  But, of course, they took the risk that it might have sold for less.

Accounts Receivable Factoring is a Quick and Easy Way for a Business Owner to Raise Cash

Many small businesses will struggle to grow if they don’t offer credit.  Allowing their customers to buy things on account.  And then paying for all of their monthly purchases at one time at the end of the month.  This convenience encourages repeat customers to buy more.  And it allows them to buy things that they can sell later.  Like a restaurant owner who buys food from a restaurant supplier.  After selling prepared meals in his or her restaurant customers pay them.  Which allows the restaurant owner to pay his or her restaurant supplier at the end of the month.  A system that works well.  And benefits both supplier and customer.  That is, as long as people are dining at that restaurant.

But sometimes people stop going to restaurants.  And stop buying from other businesses.  Making it difficult for these businesses to pay their bills.  So they start paying their bills slower.  Instead of paying them in full at the end of the month they may take an extra month.  Or two.  So businesses who sold things on account have a growing list of outstanding invoices.  Or accounts receivable (A/R).  They print out their A/R aging report and they slowly see their open invoices go from 30 days to 60 days to 90 days.  Leaving them short of cash to pay their own bills.  And if they already maxed out their credit line they may be unable to borrow money.  So what other option do they have?  Here’s a hint.  Most of their outstanding accounts receivable will eventually become cash.  In time.  All they need is a way to get someone else to wait for that time to pass.

What they need is a factor.  Someone to buy their accounts receivable.  Giving them the cash they need.  While the factor will then pursue the collection of those outstanding invoices.  Most of which the customers will pay.  And it’s these invoices a factor will buy at a discount.  The small business owner loses some profit but they make up for that by getting the cash they need to pay their bills.  Accounts receivable factoring is a quick and easy way for a business owner to raise cash.  For unlike a loan there is no review of a company’s assets and liabilities.  No collateral to pledge.  No financial statement analysis.  For the owner is selling an asset.  His or her accounts receivable.  Which is the only thing a factor looks at.  The quality of those receivables.  Which they converted into cash.  Giving business owners the money they need to get back to the business of making money.  Much like those planters did in colonial America.

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