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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The Federal Government’s entry into the Student Loan Market eliminates Market Forces

Posted by PITHOCRATES - September 7th, 2013

Week in Review

A sound banking system is a requirement for any advanced economy.  Because you need capital to make an advanced economy.  And how do you do that?  By people responsibly saving for their retirement.  Putting away a few dollars of every paycheck.  A small amount of money that can’t buy much of anything.  But when hundreds of thousands of people save a few dollars from every paycheck those small amounts become capital.  Large sums of money banks can lend out to investors who want to build factories.  Responsible bankers loaned their customers’ deposits to investors.  Investors paid the bankers interest on these loans.  And the bankers paid interest to their depositors.  The economy grew.  And people saved for their retirement.  The system worked well.  And grew the US economy into the world’s number one economy.  But now we’re in danger of dropping from that number one spot.  Because the government destroyed our banking system (see Exclusive – JPMorgan to stop making student loans by Reuters posted 9/5/2013 on Yahoo! Finance).

JPMorgan Chase & Co (NYS:JPM) will stop making student loans in October, according to a document reviewed by Reuters on Thursday, after the biggest U.S. bank concluded that competition from federal government programs limits its ability to expand the business.

When the government runs a deficit they sell bonds to finance it.  Pulling capital out of the private sector.  Raising borrowing costs.  The government then tries to lower borrowing costs by printing money.  Expanding the money supply.  And by making more money available to lend interest rates fall.  But it also does something else.  It encourages bad investments.  Malinvestments.  People who look at those artificially low interest rates and think they should borrow money when the borrowing is good.  Even when they don’t have a good investment opportunity.

They may expand their business now because money is cheap now.  Even though they don’t really need the additional capacity now.  And then if the government raises interest rates to cool the overheated economy thanks to those artificially low interest rates these same investors see their revenues fall as they took on additional expenses by expanding their business.  Just because interest rates were low.  Now their costs are higher just when their revenues have fallen.  Pushing the business towards bankruptcy.  Which would never have happened if the government didn’t encourage them to borrow money they didn’t need by keeping interest rates artificially low.

But getting people to borrow money when they don’t need it is the government’s only economic policy.  Which they took to another level in the housing market.  With pressure from the Clinton Justice Department on lenders to qualify the unqualified for loans.  Exploding the use of risky subprime lending.  And then using Fannie Mae and Freddie Mac to buy these risky subprime loans from these lenders.  Removing all risks from these lenders and passing them on to the taxpayers.  To encourage these lenders to lower their lending standards.  So they would keep making risky loans.  Which they were more than willing to do if they incurred no risk in making these loans.  Which Fannie Mae and Freddie Mac did for them.  Thus further destroying the banking system.

And now the government has taken over student loans.  Where they will do to student loans what they did to home mortgages.  Where lending decisions will be made for political reasons instead of objective lending standards.  Guaranteeing more subprime mortgage crises in the future.  A further destruction of the banking system.  And the destruction of one of the pillars of an advanced economy.

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FT118: ” It’s better to have rich investors risk their wealth than having the government risk our taxes.” -Old Pithy

Posted by PITHOCRATES - May 18th, 2012

Fundamental Truth

It wasn’t the Private Investors who lost Half a Billion Dollars on Solyndra

It takes money to create jobs.  Some conveniently forget this fact when the politicians want to take money away from rich people who got rich by creating jobs.  But the politicians always remember this fact when they want to ‘invest’ our tax money into projects to create jobs.  When they want to spend our taxes they then fully understand the concept that it takes money to create jobs.  Funny how that works.

Also funny is that the projects the politicians want to invest in are not projects the rich investors want to invest in.  Because it’s their wealth they’re risking they are a little choosier in deciding where to invest it.  So they don’t invest in these losers the politicians champion.  For even though these politicians are Ivy League graduates who are smarter than everyone else they only like to risk other people’s money.  Unless they have inside information.  Such as pending legislation that will affect the market.  Then they’ll invest their own money.  But that’s the only time.  For as smart as these Ivy League graduates are they have little understanding of free market capitalism.  Or what it takes to be an entrepreneur.  And have no idea how to evaluate an investment opportunity without having inside information.

Still, politicians are so arrogant to believe that they are smarter than the market.  And that if they ‘wisely’ invest our tax money that they can do a better job than those who risk their own money.  People the politicians believe aren’t smart enough to make the best and wisest investments.  Despite their having gotten rich doing just that.  Making wise investments.  For example, it wasn’t the private investors who lost half a billion dollars on Solyndra.  For they saw the only thing keeping the solar industry afloat were government subsidies.  And any industry that requires government subsidies is not likely ever to earn a profit.  So they said ‘no’ to Solyndra and put their money in what they deemed wiser investments.  While the government invested in Solyndra.  Because they saw that as the ‘wiser’ investment.  Only to lose a half a billion of our tax dollars in the process.  Yup.  When it comes to making smart investments the politicians are regular ‘geniuses’.  And by that I mean they are actually the opposite of geniuses.  I was using sarcasm.

Politicians lose Hundreds of Billions of our Tax Dollars in Investment after Investment because they Care 

So the politicians are worse than the worst rank amateur investor.  We know it.  They know it.  At least they should know it what with their perfect record of failure.  So why do they do it?  Why do they continually take money away from the people who know how to better invest that money so they can make some of the worst investments of all time?  That’s a good question.  And we really need to think about it. 

To figure this out think about this one word.  Elections.  That’s the key.  You see, a majority of people wouldn’t vote for these politicians.  Because they want to spend our money.  They want to raise our taxes.  So they can spend it on more Solyndras.  How does that help them?  Here’s how.  People at these companies who receive this federal money are very grateful.  And to show their gratitude they make campaign contributions.  Often with some of the very money they received from the government.  Part of that ‘wise’ investment to create the ‘smart jobs’ of the future.  And why not?  There’ll be a little left over after paying some generous executive salaries and bonuses.  Why not give a little back to the people that made all of that possible?  Make a nice campaign contribution to help the politicians convince the people that they are smart and wise and deserve to win the next election.  So they can spend more of the people’s taxes.  Into other wise investments.  Like Solyndra. 

You just need one thing to make this all possible.  A bad investment.  An investment so bad that no rich people will risk their own money.  Because they know what a loser the investment is.  It has to be that bad.  So someone in the government can say rich people are evil and selfish.  That they only care about turning a profit.  That they are not interested in the jobs of the future.  Or high paying jobs with good benefits for the working man.  Like the politicians do.  They care about the people.  Instead of turning a profit.  And are willing to invest taxpayer money in the poorest of investments.  And lose hundreds of billions of our tax dollars in investment after investment.  Because they care.  More for their own self-interests but they care.  Unlike those evil rich people.  Who refuse to waste valuable investment capital.  And won’t let the people they’ve loaned it to waste it either.  Because they only care about the money.  Unlike our government.  Who has no problem throwing away trillions of our tax dollars.

Investors Invest Responsibly and know how to Pick a Winner that will Create Jobs 

Rich investors take risks when they invest their own money.  So they are very careful in how they invest it.  And when they invest it they are very interested in how that money is used.  They don’t need any oversight committees or legislation.  Because they are no one’s fool.  They are not rank amateurs.  And they appreciate the value of hard-earned money.  They have a vested interest to make sure that money is used in the most efficient manner possible.  Because it’s their money.  And they care.

Politicians invest taxpayer money.  They have no vested interest.  So they don’t care.  When they run out of money from all of their bad investments they don’t suffer any consequences.  All they do is malign rich people again to foster a little class warfare to make raising taxes on the ‘evil rich’ easier.  Then they keep on making bad investments.  Mostly to their political cronies.  Who will return some of that public money back to them in the form of a campaign contribution.

That’s why it’s better to have rich investors risk their wealth than having the government risk our taxes.  Investors will invest responsibly.  The politicians will not.  And the investors know how to pick a winner that will create jobs.  The politicians do not.  The only way they know how to make money is with inside information.  Or skimming a little off the top of the public purse.  Which is the only way to explain investments like Solyndra.  It’s either that or our politicians are just really stupid. 

What a choice.  Corrupt or stupid.  Or is it even worse?  Are they corrupt AND stupid?  If so it sure would help explain a lot.

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LESSONS LEARNED #85: “The rich pay more than their fair share of income taxes to provide tax relief for the poor and middle class.” –Old Pithy

Posted by PITHOCRATES - September 29th, 2011

Investors Pay a Lower Tax Rate on Investment Income because Investing is Riskier than Earning Income

There’s a lot of class warfare going on right now.  It’s open season on anyone deemed to be rich.  You have President Obama saying the rich don’t pay their fair share of taxes.  That it isn’t right for Warren Buffett’s secretary to pay her taxes at a lower tax rate than her boss.  Statements like this can be very misleading.  Because Warren Buffett’s secretary pays nothing in tax dollars compared to what Warren Buffett pays.  But it sure fans the flames of class warfare.  Which helps when you want to raise taxes on someone.  (Or get reelected).  Because no one wants their own tax rates to go up.  Just those on others who make more than they do.

Except, of course, Warren Buffett.  And some other millionaire investors.  Who are asking President Obama to raise their taxes.  And he has obliged.  At least, he’s trying.  He wants to implement a millionaire’s income tax.  A little extra from those who can most afford it.  Of course, Warren Buffett won’t pay this millionaire’s income tax.  Because he doesn’t pay income taxes.  He’s an investor.  He pays capital gains taxes.

Investors pay a lower tax rate on capital gains than on income.  Because investing has risk.  Working doesn’t.  You never risk losing your income by working.  But you risk your capital by investing.  Hence the lower rate to encourage this risky behavior.  Investing in others.  Like entrepreneurs.  Some of who strike it rich.  Many more, sad to say, fail.  And investors lose everything they invested.  It’s a risky business for investors.  That’s why when their investments pay off they pay off big.  To cover all of those investments where they lost everything.  Raising tax rates on investors, then, would dissuade investment.  Stop the job and wealth creation these successful  entrepreneurs provide.  And deprive the treasury of all the tax revenue they would have created.

The Rich are Paying a Premium in Taxes for being Successful

Let’s look at some data.  Let’s mine some IRS tax returns.  See who is paying income taxes.  And who isn’t paying their fair share.  Let’s break the numbers down into 4 groups.

The poor and middle class (those earning up to $50,000 per year).  The middle class/upper middle class (those earning from $50,000 to $100,000).  The elite white collar and small business owners (from $100,000 to $500,000).  And the rich (over $500,000).  These breakdowns and labeling is not an exact science.  But it’s close enough for analysis.  Below we’ve graphed both percent of total income.  And percent of total taxes paid.  For each of these groups.  All data is mined from SOI Tax Stats – Individual Income Tax Rates and Tax Shares.  And crunched in an Excel spreadsheet.

These are the rich people.  Note that they pay a larger percentage of total taxes than their percentage of total income.  The red line is always well above the blue line.  On average their share of taxes is 8.54% greater than their share of income for the years graphed.  So the rich are paying a premium in taxes for being successful.

Of particular interest is what happens to the rich during a recession.  At both the early and late 2000s recessions their share of income tanked.  As did their share of taxes.  Their share of total taxes fell some 5% in the early 2000 recession.  With a third or so of all taxes coming from these rich, when they lose money so does the U.S. treasury.  This quickly revised those Clinton projected surpluses into deficits.  And it wasn’t anything George W. Bush did.  This was the fallout from the bursting of the dot-com bubble (it was the irrational exuberance that made all of this wealth and tax revenue in the first place.  That and the Lost Decade in Japan.  Not the Clinton tax rate hikes).  Rich people lost money; rich people paid less taxes.

And speaking of Democrat Bill Clinton, note how the rich got richer when he was president.  Not what you would expect from a Democrat.  The champions of class warfare.  But it is true.  While Bill Clinton was president the rich’s slice of the income pie grew approximately 10.51%.  Gee, I wonder what happened to the poor and middle class during this same time.

White Collar Workers and Small Business Owners have a Tax Share Greater than their Income Share

Now let’s take a look at the elite white collar workers and small business owners.  Management, professionals, doctors, lawyers, entrepreneurs, etc.  Here we see that they, too, pay a larger percentage of total taxes than their percentage of total income.  But not as much.  Their tax premium for success is not as great as it is for the rich.  It averaged approximately 3.42% for the years graphed.

Note that the recession didn’t have as great as an effect on them as it did for the rich.  They don’t have as much to gamble with.  The less risk the less reward.  And the fewer losses.  Besides, with small business owners slow and steady wins the race.  They pour all of their investment capital (i.e., their earnings) into their businesses.  And then work 80+ hours a week to wring out every last dime from that investment.

Some industries weather recessions better than others.  Some just get by.  Conservative by nature, they expand during good times.  But not too much that they can’t sustain the larger size during bad times.  For they aren’t rich enough to absorb large losses during really bad times.  Unlike rich investors.  So their income growth is flatter.  But more steady.

The Middle Class/Upper Middle Class have a Tax Share Less than their Income Share

Now the middle class/upper middle class.  Those earning from $50,000 to $100,000.  Typically those living well while still working for someone else.  Note that their share of the tax burden has been in a decline.  Much like their income.  However bad that is, they do pay a smaller percentage of the total tax than their percentage of total income.  The blue line is above the red line.  In other words, they have a tax discount.  A discount that has averaged 5.33% over the years graphed.

Interestingly, these graphs are almost the mirror image of those earning $500,000 or more.  Particularly strange is that their share of the income increases during times of recession.  Which probably reflects their incomes being a larger percentage of the remaining pie after the rich lose so much during bad economic times.

Did the Poor and Middle Class get Poorer under Bill Clinton?

And now the poor and middle class.  Whose share of the tax burden has also been in decline.  As has been their income.  But they, too, pay a smaller percentage of the total tax than their percentage of total income.  Their tax discount has averaged 6.62% for the years graphed.  Which is even more generous than that given to those earning $50,000 to $100,000.

Remember how the rich got richer under Democrat Bill Clinton?  Well as they got richer the poor and middle class got poorer.  Again, not what you would expect from a Democrat in office.  While Bill Clinton was president the poor and middle class’ slice of the income pie decreased approximately 11.85%.  Can this be true?

When the Rich get Richer the Poor get Fewer in Numbers

Well, yes and no.  If you look at the number of returns filed you find out something interesting.  Not only did income decrease for those earning $50,000 or less, their numbers shrank, too.  To illustrate this we’ve compared the number of income tax returns for our income group breakdowns for the years 1996 and 2000 (the beginning and end of the Clinton years for the data graphed).

There was a net decline of 8.85% of people earning $50,000 or less.  Where did they go?  To a higher income group.  The poorest earners in our breakout decreased in numbers.  While the higher income groups all increased in numbers.  Meaning when the rich get richer the poor get fewer in numbers.  In other words, a rising tide raises all boats.

The Best Way to Raise Tax Revenue is to let Rich People get Rich

So what have we learned?  First of all, the rich pay more than their fair share in taxes.  In fact, they pay a portion of the taxes of those earning less than them.  That is, the rich provide tax relief for the poor and middle class.

So the rich getting richer is good.  The richer they get the larger percentage of the total tax burden they pay.  And the more people they move from lower income groups to higher income groups.  By providing investment capital to entrepreneurs.  Who create jobs.  That give the poor and middle class better opportunity.

And the more jobs the more taxpayers there are.  So you have the rich getting richer and paying more taxes.  And these new employees in higher paying jobs paying more in taxes.

Now that’s good tax policy.  If your goal of tax policy is to raise tax revenue.  And if it is then the best way to do that is to let people get rich.

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