As the president signs the trillion-dollar stimulus package into law, financial networks are abuzz with investment pundits speculating on what companies will benefit, and thus what stocks should be purchased. Such analysis makes an error of causality commonly found in equities research, writes Mark Pribonic. It assumes a direct correlation between business activity and stock prices. FULL ARTICLE
Source link: http://archive.mises.org/9557/stimulus-savings-and-stocks/
Stimulus, Savings, and Stocks
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These arguments are unconvincing. It is true that stock returns come from both dividends and price appreciation, and this is the key. The model of expected revenue and earnings growth, so long as it also accounts for the percentage of earnings to be released in dividends, is sound. If prices remain stagnant due to low savings, this simply means that the return from dividends (the dividend yield) grows proportionately. This in turn reflects the low amount of savings – low savings increases the price of savings, or real interest rates. These are mirrored in the dividend yields on equities. When savings artificially flood the market, they not only lower debt interest rates, they lower dividend yields – because the same number of dividends is released to stocks that are bid up in price by artificially higher savings.
Low prices in the capital markets should be welcomed for equity investors, because the dividend yield for equities varies inversely with the price of stocks. So long as savings are low, equities can be purchased cheaply by those with savings, and will yield proportionately higher returns as predicted by the laws of supply and demand.
hi my name is jhon smith and i wanna join your comunity so pls replay me
thank you
jhon smith
Savings
“This question is a subset of the larger question of why individuals invest. The reason, of course, is to make money on existing savings.”
No, the reason is because banks no longer pay interests and even charge us endless fees instead. Also inflation eats up all of our savings. So we have to invest somewhere if we hope to make it. Thanks to governments and banks, cash is trash.
But then again, stocks have proven to be trash, munis will be trash since entire states are now bankrupt.
Maybe gold and precious metals but if prices should fall, tough luck for the next 25 years like in the 1980′s.
Now, companies are cutting in their dividends so we can forget about those.
The only thing left is price appreciation, and with Obama’s socialism running afool, we can bet to assist to price depreciation.
We are FUCKED !
The pool of investors do control the prices in the markets. And as that pool increased with the participation of individuals through ETF’s has added to the volitility of the markets on the upside as well as the downside.
Option trading in the past was limited to those that had the approved account and those that knew somewhat what they were doing. Now, every investor can play the option’s markets through ETF’s within their individual investment account. This has expanded the ability for investors to play the short side of a basket of stocks. And it is this increased volume of shorts that have led to the rapid decrease in the markets.
But the one thing to remember, a trend will not last forever. The trick is to trade within movement of the masses. As I have said before, investing is more about psychology than the hard facts.
There is a very important distortion of the investment markets that I have never seen anyone address. All economic models and discussions make assumptions about investors being intelligent, free actors. This is not true for a large segment of those donating money to the markets.
Every week, millions of people contribute billions of dollars to 401K plans, IRAs, pensions, and other socialist investment schemes. The contributors make uninformed, nay ignorant, decisions of how these monies will be invested and money managers are charged with implementing their ill-formed wishes. This financial infusion flows into the investment markets rain or shine with no intelligent thought as to whether it belongs in the place it is allocated to but still constrained by law or contract to be sent there.
This flow of capital represents a very substantial component of available savings since most people with disposable income have been conditioned to believe they should donate to communal funds and seek composite returns on investment. Just as Mises demonstrated that central government cannot solve the price problem, communal investment strategies implemented en masse do not make wise allocations of capital. The result is that it is squandered and looted by its custodians and shrewd market participants.
The flaw in all our free market reasoning is to assume we are dealing with a market of informed, independent actors. A large segment of participants are passive and ignorant. Consider how financial advisors work with ordinary people seeking to build their portfolios. Neither side is qualified in the way that Warren Buffet is to make specific investments in particular corporations or business deals. They look at percentage returns and aggregate performance of baskets of stocks, bonds, and other instruments. Diversification to spread risk is substituted for knowledgeable targeting of sane investments. And for most retirement plan participants it is even worse–they are presented with a dozen fund alternatives with catchy names and asked to check a box where their “hard earned dollars” will be flushed away.
This leads to vast amounts of capital infusions to faddish and formerly useful places where it does not belong and will be wasted or worse. A fool and his gold will soon be parted, and the stock market functions perfectly in this regard for millions of fools. Where did the dot com boom really come from? Not a need for e-commerce, but a need for sopping up billions from baby boomers who believed that stocks were the best place for their money. There was a demand for stocks, and like any good market, the stock market met that demand with fluffy IPOs to sponge up the excess capital. There was too much money flowing into a place it was not needed, but the recipients were glad to accept it and eliminate the overabundance into their own pockets.
The iron clad laws of economics operate at every level. We need to recognize that our economy is violating one of the axiomatic laws of economics requiring that participants be intelligent actors to create correct prices and signals for the system to work. Over the last 30 years the government and financial industries have encouraged and constrained the common man to participate in communal, socialized investment. This is to the advantage of the governors and magnates, but it has destroyed the individual participants and distorted the markets.
The baby boom generation is going to lose everything they worked for and blame the government and their investment and pension managers. The reality is that they should have taken responsibility for their welfare and allowed Foxy Loxy to run and ruin their lives. Nevertheless, in the field of Austrian economics we should not be naive about this component of financial collapse. We are witnessing the apocalypse of communized investment.
Excellent, excellent article! Haven’t seen those in a while…
A nice expose on stocks – of their price relationship to the issuing entity’s performance.
TO: David Spellman
Amen. Well said! Enjoyed your post.
I’m sorry but these recent posts entirely miss the point, as did the original article. There is no legitimate case against mutual funds, as they are funded by voluntary contract. There is no law of economics that says men must be rational – the laws of economics say that men’s desires (both rational and irrational) are satisfied maximally by the free market. Your complaints are exactly the ones used to justify burdensome regulation of the capital markets in the name of “transparency”. While there is much silliness in the realm of investment, there is silliness in every industry. As those who make poor choices lose their money, that capital is quickly re-allocated to savvier men, who will use it to increase the productivity of the economy and create wealth for everyone.
A side note: the dot-com boom was not caused by “irrational exuberance”, as Greenspan would have it and as you apparently also believe. Bubbles are inflationary (and thus artificial) booms caused by monetary expansion via fractional banking. The shape that they take (tech stocks, housing, etc) changes with circumstances – but the fundamental reason for the clustering of entrepreneurial (i.e., investment) errors is the distortion caused by the Fed.
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