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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Capitalism vs. Communism, Socialism, Occupy Wall Street and President Obama

Posted by PITHOCRATES - October 14th, 2011

The Corporation was Created to Raise Capital and Manage Risk so they can Build the Stuff we Want

No wonder the Occupy Wall Street people have their heads filled with nonsense.  Here’s an Ivy League publication that doesn’t even understand what a stakeholder in a corporation is.  They have a stake, i.e., a share.  They own stock.  They’ve risked their capital.  And if you don’t risk capital, then you’re just not a stakeholder (see Occupy Wall Street: What Businesses Need to Know by Hari Bapuji and Suhaib Riaz posted 10/14/2011 on the Harvard Business Review).

The demonstrators are asserting that they are stakeholders in American business, and they’re correct — they are stakeholders, as consumers, as employees, and as citizens affected by the financial system in general.

No they’re not.  Unless they bought stock in these corporations.  Which I doubt, because people typically don’t protest against companies they invest in.  Unless they’re idiots.

The corporation was created to raise large amounts of capital.  And manage risk.  By selling stocks to shareholders.  So they can raise the money to build the stuff we want.  Things that hopefully would make a profit one day.  A profit that the shareholders would share in.  As they are the ones taking the BIGGEST risk.  The corporate officers of these corporations have a fiduciary responsibility with the shareholders.  To make a profit.  It’s their company.  They paid for it.  And these shareholders owe nothing to that mob on Wall Street.  Unless any of them own stock.

You’d think those writing for a business school would understand basic business 101.

Businesses should look at whether existing models of compensation are contributing to this inequality. They need to find ways to reward performance without increasing pay disparities. Developing new models of compensation and governance is not easy and can only be possible through a long-term and sincere engagement with a wide set of stakeholders, such as regulators, academics, and representatives of workers.

They want to do away with merit.  And introduce something more akin to communism.  Where everyone is equal.  No matter the value of their work.  People have tried this.  In North KoreaCuba.  And the former Soviet Union.  Note the word ‘former’ in that last one.  There’s a reason why it’s former.  No one wanted to do the harder jobs if they didn’t get paid any more for the additional brain power or risk.  And those stuck carrying the weight of their comrades?  They just didn’t bust their ass in the process.  And that’s why the Soviet Union is a ‘former’ union.

But this is what the Occupy Wall Street people want.  Force people to do those harder jobs.  But pay these wealth creators no more than them.  Even if they only work at a Starbucks.  Or collect government assistance.

The Egalitarian Polices of the Great Society Destroyed the Economy in the Seventies

So an Ivy League publication doesn’t understand business.  But you know who does?  Al Jazeera.  Their conclusions are all wrong but at least they get a lot of stuff right along the way (see The instability of inequality by Nouriel Roubini posted 10/14/2011 on Al Jazeera).

While these protests have no unified theme, they express in different ways the serious concerns of the world’s working and middle classes about their prospects in the face of the growing concentration of power among economic, financial, and political elites. The causes of their concern are clear enough: high unemployment and underemployment in advanced and emerging economies; inadequate skills and education for young people and workers to compete in a globalised world; resentment against corruption, including legalised forms like lobbying; and a sharp rise in income and wealth inequality in advanced and fast-growing emerging-market economies.

Of course, the malaise that so many people feel cannot be reduced to one factor. For example, the rise in inequality has many causes: the addition of 2.3 billion Chinese and Indians to the global labour force, which is reducing the jobs and wages of unskilled blue-collar and off-shorable white-collar workers in advanced economies; skill-biased technological change; winner-take-all effects; early emergence of income and wealth disparities in rapidly growing, previously low-income economies; and less progressive taxation.

American industry is uncompetitive.  That appears to be the problem.  That’s why there are fewer jobs.  So people who earn income via their labor are being priced out of the market by their generous pay and benefit packages.  But people who earn their income via capital always have a place to invest capital.  Capital is capital.  It is always competitive.  That’s why more wealth is accumulating to the rich.  Because they haven’t killed their golden goose.  Like unions have killed unskilled American manufacturing.

This doesn’t explain those kids on Wall Street, though.  The ones with college degrees.  Their problem is their degrees.  Many of them are worthless.  Probably a lot of English majors out there.  Or have degrees in sociology.  Anthropology.  Philosophy.  Women studies.  Etc.  But there just aren’t a lot of stores out there selling this stuff.

The increase in private- and public-sector leverage and the related asset and credit bubbles are partly the result of inequality. Mediocre income growth for everyone but the rich in the last few decades opened a gap between incomes and spending aspirations. In Anglo-Saxon countries, the response was to democratise credit – via financial liberalisation – thereby fuelling a rise in private debt as households borrowed to make up the difference. In Europe, the gap was filled by public services – free education, health care, etc. – that were not fully financed by taxes, fuelling public deficits and debt. In both cases, debt levels eventually became unsustainable.

Too much debt is never a good thing.  But those bubbles weren’t the result of inequality.  They were the result of trying to make everyone equal.  Extending credit to the credit unworthyPutting people into houses who had no business owning a house.  That was the fault of irresponsible government policy.  Not inequality.  Just like the free education, health care, etc.  We didn’t have these problems when those things weren’t free.  And when only people who could qualify for a mortgage were getting mortgages.

The problem is not new. Karl Marx oversold socialism, but he was right in claiming that globalisation, unfettered financial capitalism, and redistribution of income and wealth from labour to capital could lead capitalism to self-destruct. As he argued, unregulated capitalism can lead to regular bouts of over-capacity, under-consumption, and the recurrence of destructive financial crises, fuelled by credit bubbles and asset-price booms and busts.

Karl Marx was wrong.  At least, he hasn’t been proven right yet.  And many have tried.  The Soviets.  The Chinese.  The North Koreans.  The Cubans.  Marxism has been an abject failure.  And those busts were made worse by monetary policy trying to eliminate them.  If credit wasn’t so cheap and mortgage standards weren’t so low there would have been no housing bubble.  It was government policy that encouraged people to accumulate debt.  Not inequality.  Government is just bad at running things.  Which is why Marxism has been an abject failure.

Thus, the rise of the social-welfare state was a response (often of market-oriented liberal democracies) to the threat of popular revolutions, socialism, and communism as the frequency and severity of economic and financial crises increased. Three decades of relative social and economic stability then ensued, from the late 1940’s until the mid-1970’s, a period when inequality fell sharply and median incomes grew rapidly.

Some of the lessons about the need for prudential regulation of the financial system were lost in the Reagan-Thatcher era, when the appetite for massive deregulation was created in part by the flaws in Europe’s social-welfare model. Those flaws were reflected in yawning fiscal deficits, regulatory overkill, and a lack of economic dynamism that led to sclerotic growth then and the eurozone’s sovereign-debt crisis now.

Government spending exploded during the Sixties.  They printed so much money in the Seventies to pay for the obligations of the Sixties that Nixon decoupled the dollar from gold.  So he could print more money.  Giving us record high interest rates.  And record high inflation.  Weak GDP.  And high unemployment.  This was all because of the egalitarian polices of the Great Society.  They destroyed the economy in the Seventies.  Reagan and Thatcher brought back prosperity.  By stopping the insanity.  They cut taxes.  Cut regulation.  And the economy took off.  It’s the reversal of the Reagan-Thatcher policies that are returning the economy to the malaise of the Seventies.  Both in the UK.  And the USA.

In the Soviet Union all of the Good Stuff came from the Decadent, Capitalist West via the Black Market

But this socialist/communist claptrap is what they’re teaching in American universities.  These protestors don’t understand the role of capital in the modern economy.  The entrepreneurial spirit.  Risk management.  They don’t understand anything other than that they weren’t born into privilege.  And this just pisses them off (see OWS’ Program? Distract From Dems’ Failures by Charles Krauthammer posted 10/14/2011 on Investors.com).

To the villainy-of-the-rich theme emanating from Washington, a child is born: Occupy Wall Street. Starbucks-sipping, Levi’s-clad, iPhone-clutching protesters denounce corporate America even as they weep for Steve Jobs, corporate titan, billionaire eight times over.

These indignant indolents saddled with their $50,000 student loans and English degrees have decided that their lack of gainful employment is rooted in the malice of the millionaires on whose homes they are now marching — to the applause of Democrats suffering acute Tea Party envy and now salivating at the energy these big-government anarchists will presumably give their cause.

Except that the real Tea Party actually had a program — less government, less regulation, less taxation, less debt.

What’s the Occupy Wall Street program? Eat the rich. Then? Haven’t gotten that far. No postprandial plans.

It’s ironic that that they hate corporate America but love to indulge in their products.

During the Cold War.  When there was full employment behind the Iron Curtain.  In the tractor factories.  People stood in line all day to buy soap and toilet paper at reasonable prices.  But they bought Levi’s on the black market.  And anything else they wanted that wasn’t dreary and drab.  Or scratchy and caustic.  Whatever the price.  Why?  Because all of the good stuff came from the decadent, capitalist West.

These protestors need to read a little history of what it was like when there was true egalitarianism.  It sucked.  That’s why Soviets defected to the U.S.  And Americans didn’t defect to the U.S.S.R.  Because capitalism was better.  People lived better under capitalism than they did under communism.

The President of the United States should not use the Risk of Civil War as a Reelection Strategy

As Krauthammer says in his column, this Occupy Wall Street movement has political motives.  Obama is following in the shoes of Jimmy Carter.  The economy is in the toilet.  His policies have all failed.  And he has no chance of reelection based on his record.  So he is using the class warfare card.  Which is irresponsible.  And dangerous.

Obama is opening a Pandora’s box. Popular resentment, easily stoked, is less easily controlled, especially when the basest of instincts are granted legitimacy by the nation’s leader.

Mobs are easy to create.  But they take on a life of their own.  Are dangerous.  And unpredictable.  The president of the United States should not use the risk of civil war as a reelection strategy.  Because it’s not exactly constitutional.  Or in keeping with the oath of office he swore.

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