Stock Market: Prudent Investment or Gambling Casino?

My father, Edward Cady Marsh, was a Wall Street investment banker. He took the train in to Wall Street each morning from Westfield, New Jersey and returned in the late afternoon. He specialized in industries such as the automobile industry, the steel industry, and the grocery industry. His compensation was based in part on his recommendations to the board, regardless of whether the board accepted and acted on his recommendations. As someone who lived through the stock market exuberance of the late 1920s and the crash and depression thereafter, he was very aware of the downside of stock market investing.

I learned early on that the profitability of a company was only one aspect to consider. The stock’s price was of equal importance. Overpaying for a very profitable company’s stock could be just as big a mistake as buying a cheap stock that had poor profitability prospects. Another factor that retail investors often overlook is the time horizon of stock market pricing. My own experience suggests that the typical stock is evaluated on a six month return basis. In other words, on average the market appears to be pricing stocks on the basis of how well they are expected to perform in six months. After the Great Recession the stock market bottomed out in March of 2009, but the economy took about six months before it was clearly heading up again.

If you get into a great stock too early, your investment may just flounder around rising and falling without much direction before it finally takes off, whenever that might be. Getting in to a good stock too early can be just as bad as getting in too late after its price to earnings ratio has reached unrealistic levels.

Another common mistake made by retail investors is sitting on too much cash and not investing for fear of short term losses. The general pattern of the stock market is to fluctuate up and down for some time and occasionally slip into a bear market, but, more importantly, suddenly move upward to establish a new level. It is these sudden upward moves, when you have too much of your investable funds in cash, that can make stock investing unprofitable. Many studies have pointed out that missing out on just of couple days of extraordinary gains in a very profitable year can eliminate most of the profit.

For the retail investor, investing in individual stocks can be very dangerous. Although most stocks tend to move up and down with the market over the short run, individual stocks can drop dramatically or move up unexpectedly. For the retail investor, investing in individual stocks is more akin to gambling that investing. As a retail investor, I have benefited from investing in broad market index funds with very low expense fees. Professional investors are much better positioned to determine which stocks are best to invest in at a particular price and time. However, sorting out the good professional investors from the bad and overcoming the fees charged by professional investors might not be worth the time and trouble. Index funds with low fees can sometimes be more cost effective and efficient than actively managed funds.

Clearly there are trends that may signal substantial increases in profitability going forward. A professional investor might consider whether the time is right to invest in stocks of companies producing lithium in anticipation of a big increase in the sales of electric vehicles that require lithium batteries. But what if there is a breakthrough in battery technology that replaces lithium with some other ingredient? In that case, the value of lithium stocks could drop dramatically.

Individualized medicine is another area ripe for expansion in coming years. Most of our doctors do not even have a sample of our DNA. Moreover, the randomized trials compare the average person’s response in the experimental condition with the average person’s response in the control condition to determine the statistical significance of the average person’s response to a drug or other medical intervention. But if the distribution is bimodal with half the people at one end and the other half at the other end, the average person may not exist. With more and more individualized data becoming more widely available, a professional investor may want to consider investing in companies with personalized medical data (e.g., DNA) that are able to zoom in to subsets of individuals sharing common characteristics to get closer to the uniqueness of an individual patient in order to provide individualized diagnosis and prognosis. For the retail investor these potential breakthroughs may introduce too much uncertainly and potential volatility but may be of interest to the professional investor.

Finally, one might consider the use of leveraged funds. Such funds provide multiples of the price movements of their corresponding indices either in the same direction (leveraged longs, UDOW) or in the opposite direction (leveraged shorts, SDOW). The opposite strategy would be to seek out the least volatile stock indices which tend to the ones that emphasize dividends. One approach might be to move from a broad based stock index fund into a fund emphasizing dividends when the stock market seems overextended in an irrational exuberance phase. If one is really into gambling, substituting broad-market leveraged shorts would be an alternative strategy at such times. On the other hand, when the stock prices have fallen significantly, one could move into broad-market leveraged longs, which could dramatically increase yields when (and if) the market recovers. Note that the expense ratios for these leveraged funds tend to be quite high and may be restricted to accredited investors.

In general, successful stock market investing requires being reasonably cautious and very patient. Most importantly, the investors style and strategy must match their personality. What works for one person may be entirely inappropriate for someone else. If you become distraught and tear your hair out when your portfolio’s value drops with a market decline, including a bear market that lasts for some time, then your style and strategy do not match your personality.

( Note none of the above commentary should be considered professional investment advice. This commentator does not accept any responsibility for losses incurred as a result of reading this commentary. Investors who want professional advice should seek out a professional investment advisor.)

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Why Punish the Poor to Stop Inflation and Make It Harder for Firms to Increase Supply?

Why Punish the Poor to Stop Inflation and Make it Harder for Firms to Increase Supply?

When the Federal Reserve raises interest rates in New York financial markets, it becomes harder for businesses to borrow, which causes businesses to cut hours, lay off workers and close outlets. This is an indirect and rather brutal way to reduce demand for goods and services that also reduces supply. The effect is to make it harder for firms to increase supply and harder for people working paycheck-to-paycheck to handle medical emergencies, automobile accidents and other situations where they need a small loan just to get by.

But trashing the economy to stop inflation is not necessary. A more direct, more efficient and more effective way to stop inflation is possible. When the demand for goods and services exceeds the supply, prices rise. Demand can be reduced with either a carrot or stick approach. Why use the stick of raising interest rates on loans that punishes poor people facing a personal crisis and businesses that want to supply more, and instead offer the carrot of higher interest rates on savings to get people to voluntarily put off unnecessary spending and save some money?

In 2018 Senator Kirsten Gillibrand introduced Senate bill S.2755 as “The Postal Banking Act” as a way to use post offices to restore the “The Postal Savings Act” of 1910 which allowed people to cash checks and set up savings accounts in the over 30,000 post offices throughout the United States from 1911 to 1966. Senator Gillibrand sought to use our local post offices as a venue for the poor to get small loans to deal with various crises without becoming prey to loan sharks, pawn shops, payday loan dealers, or “cash now” providers who typically charge exorbitant interest rates.

The Federal Reserve is already considering creating a central bank digital currency (CBDC) as China and several other countries have already done. The Federal Reserve could use post offices as physical locations to access individual CBDC savings accounts. People could also register their smartphones at post offices for more direct and immediate access to their CBDC accounts. When excessive inflation threatens, these CBDC accounts could offer a high interest rate on savings. Encouraging people to save money and spend less will reduce the excess demand where too much money is chasing too few goods and driving up prices.

Ordinarily, to make a profit a bank must charge a higher interest rate on loans than it pays on savings. But as the creator of money, the Federal Reserve is in a unique position. To reduce demand for goods and services, the Fed can offer a higher interest rate on savings. However, in line with “The Postal Savings Act” of 1910 and in order to avoid disrupting commercial banking, the Fed will need to set a limit on the size of savings accounts. With one account per Social Security number and a limit of $10,000 per account, the Fed can avoid competing with private banks for the large savings of wealthy investors.

Encouraging people to build up their savings will also serve as an automatic stabilizer for the economy. Whenever an economic downturn threatens, people with savings do not have to cut their expenditures so dramatically. This avoids a sudden drop in expenditures which would just make economic downturns more severe. A larger pool of savings would shorten and lessen the severity of recessions.

If everyone had a Federal Reserve bank account accessible from their computer or smartphone, it would become easier to transfer money. If someone cuts your grass, rakes your leaves or shovels your snow, you can pay them easily with a smartphone-to-smartphone transfer between your individual Federal Reserve accounts.

Alternatively, when inflation is low and unemployment rises, the Fed could lower the interest rates on both savings and loans to help stimulate the economy. This new tool would give the Fed much tighter control in meeting its mandate of maintaining full employment with stable prices.

Large banks already have bank accounts with the Federal Reserve. There is no reason why the rest of us couldn’t also have bank accounts with the Fed. The rise of digital currencies, especially stablecoins, threaten the Federal Reserve’s dominance and control over our currency. By setting up digital currency smartphone postal savings accounts for every American, the Fed can reestablish its control over our currency and gain a much better way of dealing with the challenge of excessive inflation on one hand and high levels of unemployment on the other.

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