Choose your own stock market adventure

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If you are fortunate to be living off sizable and broadly diversified investments in the world’s financial markets, then your financial position by mid-August likely came back pretty close to where it was in January of 2020, before the “Coronavirus Crash.” This is especially true when dividends and interest payments received since then are included. And if you are not? Well, the wealth gap in the U.S. has just widened another step further.

We are at this point in the recovery of the broader stock market despite now officially being in a very deep recession. Millions of Americans out of work, many of them permanently, and mostly these are the same people who have no financial market investments. You can choose to read numerous pundits as to why so many are doing so well financially while so many millions more are hurting. Or you can read my summary take here and choose your favorite reality from my list. We will start with some short-run answers, graduating to the longer-term reasons at the end.

S&P 500 index year-to-date – August 2020. Source: finance.google.com

A lumpy recession and lumpier recovery.  To be sure, many investors are still not “whole.” The recovery in stock values has mostly been in the well-diversified funds representing the S&P 500 and other broad market measures. The “Big Tech” stocks (Amazon,  Apple, Microsoft, etc.) have taken on an increasing proportion of these indices, and they have performed very well in the last five months, while the rest of the market overall is still performing weakly. Simple diversification has its advantages. If you had all of your money in, say, conventional retail stocks (Stein Mart, for instance, now in bankruptcy), you join the ranks of the unequally hard-hit.

The Federal Reserve is flooding the market to keep it solvent. If you are sitting on a lot of cash (important: many very rich people are still sitting on LOTS of cash) that money needs to go somewhere. The U.S. Federal Reserve has committed to keeping interest rates on debt very low, and so the stock market remains one of the few hedges against inflation and source of long-term returns.

The end is near! It is still indeed possible that a second crash is coming, and even imminent. Keep predicting one and at some point, you will be correct. But if you cashed out when the “Coronavirus Crash” first hit, you have lost a lot of the market recovery gains in the last few months. If the market is anywhere near efficient, then half of the investors are still buying today, betting on continued market strength, while half are selling. My long-time stance, going back to trying to pick stocks from rural Iowa many years ago, is to assume that the market is “efficient enough” for rural Iowa investors, and indeed, still “efficient enough” for most readers of this blog. Hot tips aren’t really hot in a computerized market, and as Burton Malkiel has long advised, market prophets are statistically very close to coin flip predictors.

The marginal investors determine the short term. My view here is that market prices are based primarily on the daily multi-million-dollar bets of the marginal investors, those people and computer algorithms who want to/must buy or sell right now. And those bets often look like a curling match, with lots of sweeping but only tiny marginal advantages. Those of us who “buy and hold” stocks and funds are simply riding the wave caused by these “market sweepers.” Our petite-size investments from months or years past are what accountants called “sunk costs,” and have no effect on the current market. The March “Coronavirus crash” pushed a brief flurry of “buy-and-hold” investors back into the market, mostly selling. In hindsight, they were mostly taken advantage of, selling near the temporary market bottom. But I could be wrong tomorrow when the next “end” finally comes.

Successful business “rent-seeking.” As I have written in the past, a major swath of U.S. corporations have convinced Republicans to perpetually privatize their gains in good times, mostly through massive tax decreases, deregulation and privatized government functions. At the same time, the big money in the Coronavirus recovery government aid has gone to socialize the losses of these same players. The owners of these companies have near-guaranteed income stability in very bad economic times. Ever-increasing “military spending” is, in reality, mostly just corporate welfare in disguise, building stuff and blowing it up. Republicans do not really believe in minimizing government deficits when they are in power.

International business buffers. Some countries have not been hit as hard by the coronavirus or have taken better measures to defeat the virus and protect their own economies. Broadly-diversified investors have a measure of downside protection in the worldwide trade of fungible goods that local factory workers do not have.

Thomas Piketty and “r > g”. French economist Thomas Piketty’s 2013 tome, Capital in the Twenty-First Century, raised a lot of ruckus by documenting that the richest capital holders are on a permanent distancing path of increasing income inequality from the “laboring rabble.” The recent market movements suggest that Piketty is indeed correct, and that large, diversified holders of capital remain quite protected from big market fluctuations, even those as significant as from a worldwide pandemic.

Piketty’s claim was based on his analysis of many years of worldwide economic data demonstrating that the long-term economic returns on capital holdings ( r ) are greater than the rate of long-term economic growth ( g ). Thus, unless constrained by governmental policy, the income of those living off their capital will continue to outpace, percentage-wise, those living off their labor, and the gap will do nothing but grow. And they get tax advantages over labor income to boot. [1]

This is true not just for the mega-rich but also to a lesser degree for smaller S&P 500 diversified fund holders. A while back I explored my favorite market graph, which simulates the returns of an “income-averaging,” buy-and-hold investment strategy in the S&P 500 stocks over decades. The green lines trace the wide variance in returns for any one day’s purchases, while the dark line through the middle shows a steady 7% after-inflation average return on the total portfolio over the long-run (on a logarithmic scale).

S&P 500 Returns

We are not through with the economic impacts of this virus by a long shot, and I am still waiting to see the impacts of the “bullets that we don’t hear” right now. What does the commercial real estate market look like long-term, for instance, if 25% of the need for urban office space goes away because of a successful work-at-home culture has developed? What happens if the U.S. continues to fail at containing the virus and its down-side economic impacts? Who will be the next major corporation to go into bankruptcy?

I have been pretty pessimistic since the beginning when I first documented how people in power were downplaying the mathematics of exponential Covid-19 growth. Those same people still deny the math and the best scientific mitigations as our children go back to school in places like Florida where infection rates are still very high and where a lot of older people live. Gee, what could go wrong?


Notes:

  1. I addressed this thirty-year differential in income inequality over two years ago in a series of posts.

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