The Coronavirus Crisis: How the Trump Administration is Pushing Stock Prices Down

The financial markets hate uncertainty.  When the picture isn't clear, stock prices get wobbly.  Before today, the coronavirus epidemic had already pushed stocks into a correction (i.e., a drop of 10% or more).  To make things worse, the Trump Administration has been trying to downplay the scope, risks and impact of the epidemic while federal health officials have endeavored to be realistic.  (See https://www.cnn.com/2020/03/09/politics/cdc-policy-test-kits-coronavirus/index.html.)  This informational squabble cast doubt where doubt could do the most harm.

The coronavirus epidemic is the largest driving force in the stock market today.  The disease has slowed the world economy and sharply reduced demand for petroleum, which has hit oil prices hard.  Major oil producing nations, including the members of OPEC and Russia, tried to work out a way to prop up oil prices this past weekend but failed.  This morning, oil prices plummeted into the $30 to $35 range for West Texas Intermediate.  That implies gas prices around $1.50 to $1.60 per gallon, compared to current retail prices around $2.20 to $2.50 in many parts of the country. 

The cratering oil prices exerted fresh downward pressure on stock prices today, so much so that a stock market circuit breaker was triggered for the first time after the S&P 500 fell 7%.  Trading was halted for 15 minutes and then resumed, with stock prices remaining moribund. 

When the markets don't have adequate information, investors are cautious about the prices they'll pay.  When a flood of selling takes place because of inadequate information, buyers will be reluctant to step forward and invest, even when prices drop significantly.  Holders of stocks, faced with uncertainty over the future, will be inclined to sell even more rather than run the risk of additional losses.  Fear spreads and selling increases.  Had the Trump Administration been forthright about the coronavirus epidemic, stock prices would have been impacted, but investors would have been more confident about stepping in and buying.  By creating an informational fog, the Trump Administration exacerbated selling pressure and dampened buying interest.  This is no way to restore confidence in the market.

The Trump Administration is certainly not the only government that has been economical with candor concerning the coronavirus epidemic.  The combined governmental obfuscation has been precisely what stock prices don't need.  But there are few signs of unvarnished governmental veracity on the horizon.  Expect more nausea in the markets.

Donald Trump's Very Bad Day in the Stock Market

Today, March 4, President Trump had a very bad day in the stock market.  Yesterday, Super Tuesday for the Presidential primaries, Joe Biden won a series of contests among the Democrats and took the lead in delegates over his principal rival, Bernie Sanders.  Today, the Dow Jones Industrial Average rose almost 1,200 points in celebration. 

Since before his inauguration, Trump has touted a buoyant stock market as one of the hallmarks of his Presidency.  To him, it signaled approval, achievement and prosperity.  Whenever the market showed signs of queasiness, Trump was quick to pummel the Federal Reserve Board for interest rate cuts to prop up stocks.  Trump equated stocks with himself, and stocks seemed to reciprocate.

But not today.  Today, the market loved Joe Biden.  And Trump could only watch the love fest. The market no longer needs him.  It can bounce up with Biden in the White House.  The contest for the Democratic Presidential nomination is far from over.  Biden's lead over Sanders is modest, with close to two-thirds of the delegates yet to be chosen.  Many of the remaining primaries are in Western and Midwestern states, where the demographics may be more favorable to Sanders.  But if Biden can maintain his momentum and secure the nomination, Trump won't be able to count on the stock market for support.

Do the Unicorns Signal a Market Peak?

Unicorns in the financial markets bear scant resemblance to the gentle creatures of mythology.  Companies with private valuations of $1 billion or more, called "unicorns" by investors, have been going public recently after many years of incubation by private funding.  The results haven't been pretty.  Two of the largest--Lyft and Uber--have lost value.  Snap, another large company that went public a couple of years ago, has also lost value. The sagging values of these high profile companies raise a question whether investor confidence is receding and the market is potentially headed for a downturn.

Much of the reason for the price drops is attributed to the long incubation periods for these companies, during which their values rose into the billions.  Whereas 20 or 25 years ago, companies might go public after having achieved valuations of a few tens of millions, unicorns have provided enormous returns to venture capitalists, early employees and other private investors before the retail schlemiel is given a chance to lose his money.  In other words, the upside pop that often accompanied ipo's in the past has already been pocketed by the smart money.  What remains for Ma and Pa trying put a little money into their IRAs is the uncertainty of companies that have yet to consistently turn a profit.

A hot ipo market fuels overall stock values.  Look at the 1990's, when ipo enthusiasm grew so vast that things got out of hand and the 2000-01 downturn took some 70% off the value of the Nasdaq index.  The recent unicorn fails will dampen further ipo activity.  The smart money was too clever by half in using ipo's as a way to vividly demonstrate to retail investors that they are but a septic system for the rich and well-connected. As President Trump's trade wars continue, the chances for a no-deal Brexit increase, and investor enthusiasm wane, the chances for a significant market downturn rise.  The unicorn ipos may signal a peak in stock prices.  Embrace cash.  In uncertain times, it's worth its weight in gold.

How Donald Trump Could Create a Stock Market Crash

Stock market crashes, such as in 2008, emanate from inflated asset prices.  While economic recessions and other events, such as war, can trigger market downturns, large, sharp market drops (a/k/a crashes) are the result of artificially high asset prices that often have started bubbling.  In 2008, the asset bubbles resulted from overly generous prices being paid for real estate, the resulting mortgages, stocks that seemed like good bets in light of all the real estate activity, and stocks generally because market averages kept rising.  It didn't help that the U.S. government guaranteed almost all mortgages on a de facto or de jure basis.  The easiest way to get people to pay too much for an asset is to make it seem like a sure bet.  Con men know this and profit from it because, despite all the evidence that there is no such thing as a sure bet except taxes and death, people remain suckers for sure bets. 

Donald Trump bet the image of his Presidency on the rising stock market.  Stocks rose briskly right after Election Day in 2016 and maintained their upward momentum for over a year.  Trump noisily celebrated the huzzahs he thought he heard from the financial markets and wore out the fabric of his suit jackets patting himself on the back.

But Trump, despite decades as a New York businessman, hasn't absorbed a simple lesson that he should have learned about stocks a long time ago:   that stocks go up and stocks go down.  There is no such thing in the stock markets as continuing upward momentum.  There is no endless applause.

So, when the stock markets got tummy trouble in 2018, and began to burp, belch and make other inelegant noises, Trump became discombobulated.  He berated the Federal Reserve Board for raising interest rates, manipulated oil prices down by persuading the Saudis to keep pumping large volumes, and condemned American businesses that closed down domestic operations.  Sometimes, on down days in the market, he made statements about trade talks that turned out to be optimistic or premature.  He seemed indifferent to widening federal deficits, instead suggesting a further tax cut for the middle class.  All of these actions seem linked to a desire to support stock prices.  But stocks have remained gloomy.  So we can expect that Trump will keep searching for some way to boost the metric that he thought made him look so good.

Persistent efforts by governments to support and boost asset prices have tended to end badly.  There is no free lunch, and governmental distortion of asset prices inevitably leads to misallocation of capital and other resources.  Pushed far enough, this mispricing eventually becomes too much for investors to stomach, and they back away from the asset. Then, bad things happen to the asset's price. That happened with real estate and mortgages in 2008 and it may be happening with stocks now.  If Trump pushes too hard on maintaining and increasing stock prices, he could foster a bubble in the stock markets, and nothing good for him will result from that.  If you're an investor, don't bet on governmental action to make stocks great again.  Remember:  in the final analysis, stocks go up and stocks go down.

Where Is the Stock Market Headed?

With the Dow Jones Industrial Average having dropped over 2,000 points since its peak a week and a half ago, this is the $64,000 (or more) question.  The recent market surge resulted to a large degree from too much optimism.  Market players have selectively focused on the good news (strengthening economy, big corporate tax cut, rising employment levels), while shrugging off the bad news (growing signs of inflation, rising interest rates, and increasing political discord).  Life is like a rose--pretty petals, but thorns as well.  If you ignore the thorns, you'll get an ouchie sooner or later.

So what happens after today's ouchie (1175 points off the Dow)?  The recent market surge seems similar to the valuation-driven bull markets of 1987 and 2000, which resulted in sizable drops of 25% to 30% in the Dow followed by gradual recoveries that took two to three years.  But we should bear in mind an earlier drop off. In 1973, the stock market (measured by the S&P 500) peaked after a long run up, not unlike the one we've had since 2009.  Then, it declined some 40% or more and didn't recover until some seven years later.  The 1970s were also a time of rising inflation and political scandal (Watergate), with the only resignation of a President.  Political turmoil affects economies and stock markets (look at Venezuela, where a lot of folks can't even get a square meal because of political strife).

Expect more market turmoil tomorrow, the next week, the next month, and maybe the next year.  The market could easily drop some more.  We're running out of good news.  There may be little major legislation coming out of Washington, given the political quagmire.  The Fed may go easy on the tightening, but it's not going to cut interest rates simply to support stock prices.  It's already done that, perhaps too much--and today's drop was likely a consequence.  The economy seems to be slowly gaining altitude.  But there's nothing going on that will provide it a quick major boost.  The federal government can't increase the deficit, given its recent deficit-funded splurge with the tax cut bill.  Corporations seem not to be rushing to increase reinvestment of their tax savings.  The Trump administration may spark a trade war with China and other nations.  And the stability of the federal government cannot, in these times that try our souls, be taken for granted.

History teaches that it's not a great idea to sell your stocks in an effort to staunch losses.  People who try to time the market generally fail to get back in and enjoy the resurge that will likely come (although the resurge could be a long time coming). Instead, try to spend less and save more.  Keep your investments diversified.  And don't stop knocking on wood.

Hurricane Harvey? North Korean Missiles? Stocks Shrug

So, okay, Hurricane Harvey may be the worst storm to hit America in a while.  The damage is really bad, and getting worse.  Projections for recovery time are lengthening by the minute as rainfall totals rise.  The economic impact will clearly be big.  Energy extraction and refining are being hit.  The Gulf states have a number of petrochemical and plastics plants, but they aren't manufacturing much.  The Gulf ports are major transshipment points for a lot of stuff, but not much transshipment is taking place.  The cost of rebuilding may reach $100 billion or more.

Meanwhile, the fat kid in North Korea keeps firing off missiles, in one instance over northern Japan.  He may think he's being clever, pushing the world to see how far he can go.  But shooting missiles over another country is a way to start wars.  The Japanese held their fire.  But North Korea's missiles aren't the picture of reliability and sturdiness.  If one flies in an unintended trajectory, or falls apart at the wrong time, physical impact on Japan or maybe South Korea is quite possible.  Then what?  Kim Jong Un has been on a path of escalation in recent months.  He's announced that Guam--U.S. territory--is his next target.  Since he seems intent on escalating, he will approach a flashpoint. 

But do stocks care?  Not one bit.  Even though U.S. stock futures dropped sharply last night, all indexes closed up today.  Mega hurricane--meh.  Barrage of North Korean missiles--meh.  Discord rife between and among the President, Congress and both political parties--meh.  Merrily we roll along.  Plus ca change, plus c'est la meme chose. 

Why do we have such insouciant stocks?  The likely explanation is the Fed.  Market participants have gotten so used to Fed bailouts that no one believes stock indexes can fall more than about 3% at the most, and therefore don't panic sell portfolios.  In some respects, this market stability may seem desirable. 

But market stability based on government subsidies is ultimately chimerical.  The Fed produced that stability by screwing over large numbers of people.  By keeping interest rates extraordinarily low for almost a decade now, the Fed has decimated pension plans.  A lot of middle class people who depended on their pensions are now lower middle class, or even poor.  Retirees and others who relied in part on interest income from their savings have learned to like dog food in lieu of steak, or even hamburger.  Holders of long term care insurance policies have faced extortionate rate increases, or possibly the prospect of spending old age in homeless shelters until they qualify for nursing homes that take Medicaid (which sometimes aren't exactly top class institutions).  Those that still have some faith in the future and want to save for a rainy day need to tighten their belts and put aside more principal, rather than count on the compounding of interest income to make their golden years glow.  That means reducing current consumption, which is a drag on the economy and may partially explain why economic growth remains tepid.

As long as the Fed supplies financial opioids for stocks to mainline, the market will be copacetic.  But problems lurk.  Stock valuations may not truly reflect investment values.  Instead, they probably incorporate a large dose of government subsidy.  That would mean people are paying too much for stocks.  This story won't have a happy ending.  Market forces can't stay suppressed indefinitely and government subsidies can't last forever.  The failure of Communism in China and the Soviet Union prove that point.  Things generally feel good when you're on narcotics. But you don't get good quality sleep on opioids--and investors shouldn't be sleeping too soundly now.

Why You Should Worry About the Rising Stock Market

The stock market keeps rising, setting new records just about every week.  The S&P 500 has risen over 15% since Election Day 2016, and shows no signs of slowing down.  That's an annualized rate of over 20% a year, which is exceptionally good for an aged bull market as we have.

The election of Donald Trump as President was seen as a major reason for the rally.  He promised infrastructure spending, tax reform and other measures that should stimulate the economy.  But his Presidency has sunk into a quagmire of chaos, incoherence and unpredictability. These, coupled with the legal risks emanating from special counsel Robert Mueller's investigation, should have triggered market retrenchment.  But stocks have hardly blinked before levitating some more.  Whatever is driving the market, it doesn't have much to do with the Trump Presidency.

Accommodative monetary policy in Europe and Japan is also said to be a reason for the market's buoyancy.  Foreign central banks have been printing money, and some of it supposedly has found its way into the U.S. markets.  But the dollar has been falling recently, indicating liquidity is flowing out of our markets, not in. That's not a formula for a rally.

Corporate earnings, although pretty decent, aren't dramatically better than last fall.  They don't explain the lighter-than-air quality of stocks today.

So what's going on?  Let's consider that over half of all stock market transactions consist of computerized trading.  Machines are trading with machines, using algorithms known to very few.  These algorithms verge on alchemy.  They rely on statistical correlations that may or may not hold true in the future.  These correlations can be disrupted by unexpected government policy, political upheaval or conflict, economic change (such as the effective collapse of OPEC as a functional cartel), and technological change (such as the fracking that just blew up OPEC).  They also utilize artificial intelligence, seeking to learn from their ongoing experiences in the market and modifying their algorithms as a result of what they learn.  Thus, the humans may have difficulty anticipating what the programs will do tomorrow.  And the programs may produce a positive or negative synergy or other interaction that humans have not foreseen.

Computerized trading is opaque.  That is, in real time, no one knows for sure if a trade or a series of trades involved a machine or two machines or none.  One should avoid anthropomorphism in today's stock markets.  In other words, one should not ascribe human motives, intentions or characteristics to market activity.  There may be no reason comprehensible to humans for today's stock prices.  When computers use artificial intelligence to trade stocks, the valuation of financial assets may be fundamentally changed, and changed beyond human comprehension.  You may think that stock prices are whacked out--and you could be correct from the human perspective.

Homilies like stocks are excellent long term investments and will protect against inflation were derived at a time when people dominated the financial markets and established the asset valuations on which these notions were based.  If machines that function opaquely suddenly become dominant, how can humans understand the valuations determined by the machines?  More succinctly, how can you tell what's a good price and what's a bad price anymore?

There are many more questions than answers in a machine-dominated market.  When the market keeps setting new record highs in machine-dominated trading, be careful.  We are bravely, or not, going where no investors have gone before.  And no one really knows what's going to happen.

Investing in a Time of Trump

If there's one notable feature of investing in the nascent Trump Presidency, it's uncertainty.  Although macroeconomic statistics are generally good, we are startled every day by a spinning kaleidoscope of tweets, leaks, executive orders, allegations, innuendoes, news stories, fake news stories and occasional court rulings that splatter across our field of vision and further contort the cognitive dissonance in the political scene from the recent election.  When all news and news-substitutes seem to be open to challenge, what can an investor rely on?

The ever-rising market only makes things worse.  With such political confusion, it's far from clear that the economic and tax policies espoused by President Trump will be implemented any time soon.  Why does the market persistently climb higher?  One can only suspect that some market participants have conflated optimism with delusion.  The background music to today's market may not be the Grand March from Aida (https://www.youtube.com/watch?v=TX0qN6QEvGg), but rather Jimi Hendrix's Purple Haze (https://www.youtube.com/watch?v=cJunCsrhJjg).

What can an investor make of all this?  Bear in mind that you can't see a lot of what's going on in the market.  There are major undercurrents, often computer driven, that cause daily market schizophrenia.  Large investors can push the market one way or another in the course of making large purchases or unwinding large holdings.  Mom and Pop investors won't see this or hear about, except maybe after the fact.

Computerized trading can be particularly scary.  It no longer consists of following pre-determined algorithms.  Much of today's computerized trading is dynamic, using artificial intelligence-type programs that try to figure out as the trading day progresses where prices are headed and buy or sell to take advantage of the anticipated market move.  Since much of the trading these programs are observing is done by other computers, we have computers reacting to other computers.  Price, which traditionally has been a judgment call made by intuitive and irrational humans, is now the product of chains of logic.  That logic tends to respond to short term stimuli, such as price movements in the last few minutes, seconds and even milliseconds.  It doesn't factor in the uncertainty in Washington.

People know the future is cloudy.  But the computers don't.  Computers don't feel fear, nor do they have to save for retirement or build up a cash reserve to guard against a layoff or a large unexpected expense.  People may hold onto their cash, wondering if the market is too bubbling given the chaos in the White House.  But a computer may boldly keep buying, egged on by the trades of the past 20 milliseconds.

If you're hesitant about the market, keep your powder dry and your cash in an FDIC guaranteed bank account.  There's no computer program that can understand and explain Donald Trump.  Today's stock market may be too heavily driven by short term inputs, without a full understanding of longer term risks.  Remember the old computer adage: garbage in, garbage out.  If today's computerized trading is pushing the market up based on an incomplete picture, prices will eventually rise too far, if they haven't already.  Then, le deluge.

Is the Central Banking Bubble Bursting?

America's economy is stuck in first gear, China's economic growth is slowing, Europe's economy is dead in the water, and Japan's economy has been lost in a fog bank for decades.  Corporate profits have been declining on a year-to-year basis.  But stocks keep reaching new highs.  Given the backdrop of pessimistic data from the real world, one must wonder how much longer the delirious jollity of the markets can continue.

It's no secret that the frothiness of stocks stems from the service-minded attitude of the world's major central banks:  they aim to please.  Accommodation is the word of the day.  Money will be printed early and often, and served on a silver platter with a flute of champagne.  The central bankers are not about to take the champagne away, even though some Federal Reserve officials occasionally mutter something or other about raising rates.  The markets know this--the futures market seem to view rate rises as likely as pigs flying.  So the central bank bubble persists.

It's true that the central banks' tools are becoming dull.  Quantitative easing--the purchasing of bonds by central banks--is playing out.  Vast amounts of government bonds have been bought up, and now corporate bonds are being targeted.  Private sector retirement savings are being pummeled by the lack of sources of reliable long term earnings.  Pension fund deficits are like festering sores, annuity payouts are shrinking, long care insurance policies are becoming extortionately expensive, and interest payments on personal savings are going the way of the passenger pigeon.  With shrinking retirement prospects, people are saving more so that they can limit the need for dog food in their retirement diets.  As a result, both current and future consumption are constrained.  Since consumption is 70% of the U.S. economy, the Fed is seeking short gains in aggregate economic statistics by sacrificing long term financial prospects.  We've had eight years of ultra low interest rates with no end in sight, and recovery from the resulting income losses will take many years, if it ever happens.

More recently, the monetary tool that has become au courant among central bankers is the negative interest rate.  Negative rates are a counter-intuitive policy where borrowers are paid to take out loans.  They are supposed to stimulate lending by penalizing commercial banks for holding deposits.  However, despite being all the rage among central banks in Europe and Japan, they haven't worked out. It seems that people, concerned by the weirdness of negative rates, aren't borrowing but instead are saving more.   See http://www.cnbc.com/2016/08/09/bonds-and-debt-negative-yields-are-doing-the-opposite-of-what-they-were-intended.html.  Negative interest rates signal that the world is not well.  People are hunkering down and building up financial reserves in case times get worse.  This, too, dampens consumption and current economic growth.

But the deleterious effects of ultra low and negative interest rates are more likely to cause further economic stagnation, not a sudden collapse of stock prices.  The reality is that central banks aren't subject to market forces the way the rest of us are.  They are, however, subject to a lot of political pressure to keep current economic statistics looking good.  They know that the political process is largely dysfunctional, and fiscal proactivity isn't on the agenda. So they keep exchanging small near term benefits for large long term costs without any immediate consequence.  The bubble won't burst simply because they are making a bad long term deal. 

Could the central banking bubble burst?  The breakup of the EU might do the trick.  A return of significant inflation would be a major risk factor.  But it's hard to predict the likelihood of either.  In the meantime, stock prices could remain manically frothy.  Central banks can't defeat market forces when the market works against them, as the Bank of England found out in 1992 when it tried to support an overvalued pound against market forces pushing the pound down.  But right now, the financial markets want the central banks to be accommodative.  They applaud the idea.  Since the central banks face no reality checks, they can keep printing money indefinitely.

So, should you suspend belief and keep buying stocks?  Certainly, seeing stocks go ever higher just about every day is encouragement to drink the Kool-Aid and invest more.  But staying well-diversified, with a healthy dollop of cash, may be the sanest choice in an insane world.

A Generation of Stagnation; Retirement Walks the Plank

We are now looking at a generation of stagnation.  The recovery from the 2008 financial crisis still wobbles like a drunk.  Even though we now have full employment, wages barely keep up with inflation (if at all).  And recent statistics indicate that inflation is growing as fast as a parched lawn.

Regardless of what this Federal Reserve official or that says, the central bank will raise rates as often as humans walk on Mars.  If you're wondering when rates will return to historical norms, the answer is never.  At least, this is the only rational assumption you can make.  With Asia's growth slowing, Europe's growth nonexistent, South America in free fall, Russia going negative in numerous ways, and the Middle East becoming more unstable with each passing day, and no drivers of growth in America except the Fed money printing presses running 24/7, the only future forecast that seems sensible is to expect stagnation for--well, the rest of your life.

With stagnation instead of brisk economic growth, the government's ability to support retirees will be limited.  While Social Security and Medicare won't disappear, they will likely be parsimonious.  If you drop your porridge bowl, they won't refill it.  And pension fund and personal investment returns are being decimated by low interest rates on bonds and bank accounts.  Your retirement is starting to walk the plank.  What to do, then, about your future?

Spend less, save more.  This is a no brainer.  It's not what the Fed wants, because hesitant consumer demand constrains economic growth.  But the Fed be damned.  Your long term well-being requires the thriftiness of Ben Franklin, and if that results in lower economic growth that makes the Fed look bad, well who cares?  (Or, you can substitute more lively terminology if you wish).  With interest rates so low, you can't use the financial magic of compounding to build much of a retirement (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html). You have to set aside more principal, and hope that the few crumbs of interest income you get will elevate your retirement diet above dog food.

Put some money in stocks.  The inequality of wealth in America has increased because the Fed's easy money policies tend to inflate asset values.  Since the rich own most assets, their wealth  has increased disproportionately from central bank policies.  Realistically, with stagnant wages and a Republican controlled Congress, you can't expect the inequality of wealth to diminish.  (Maybe things would be different if Bernie Sanders is elected President, but both the Democratic and Republican establishments are using all their smoke-filled back room influence and power to prevent that.)  So you might as well join 'em if you can't beat 'em.  Owning stocks can be gut wrenching in times of market turmoil.  But so is a retirement spent eating dog food.  Learn to live with the market's turbulence, and collect the rates of return that the 1% are getting from equities.

Work longer.  This increases your lifetime earnings, which allows you to save more and build up your Social Security benefits.  If you're lucky enough to have a pension, it will likely increase your pension benefits.  Okay, so working longer means a shorter retirement.  But, like we said, retirement is walking the plank.  Just try to avoid having to live in a cardboard box on the sidewalk with a couple of cans of cat food in your raggedy backpack.

Avoid debt.  You can't go bankrupt if you don't borrow.  If you do borrow, some of your future income will go to banks and other lenders in the form of interest payments, instead of enhancing your future lifestyle.  Granted, you may need to borrow for big ticket items like college, cars and a house.  But otherwise, avoid debt.  And pay down the debt you have as you approach retirement.  Especially, lose the mortgage.  Financial advisers may tell you it's okay to have a mortgage in retirement.  But guess what?  If you have a mortgage, that means you may have more financial assets to invest in ways that pay fees and commissions to the financial advisers.  Meanwhile, you have to pay interest on the mortgage debt.  Who's better off?

For more on ways to yank your retirement back off the plank, read http://blogger.uncleleosden.com/2009/11/techniques-for-retirement-saving.html, http://blogger.uncleleosden.com/2009/07/simplest-financial-plan-of-all.html, and http://blogger.uncleleosden.com/2011/01/hope-for-financially-lost.html.  Good luck.

How to Manipulate the Stock Market

The recent unusually close correlation between the price of oil and the prices of stocks offers an opportunity to manipulate the stock market.  A trader could purchase a large holding of stock index futures that would increase in value if the stock market rises, and then purchase oil futures contracts in rapid sequence in order to push up the price of oil.  The price jump in oil would, presumably, pump up stocks.  The stock index futures would rise in value and the trader could sell them for a quick profit.  An individual person couldn't do this, except one who is exceptionally wealthy.  But large hedge funds and other financial entities might have enough funding to pull this off.  It could be done in the U.S. markets, and some foreign markets (since the oil-stocks correlation isn't limited just to the U.S. markets).

Doing something like this could be seriously illegal.  Kids, don't try this at home, not unless you want to be a long term guest of the U.S. government at a facility not of your choosing.  But, as hardly needs to be said, not all participants in the financial markets observe the highest degree of fidelity to legal requirements.  Mega bucks could be made this way, and for some, money talks even if getting it involves stepping off the curb.  Hopefully, financial regulators worldwide are tuned into this possibility.  The recent exceptional volatility in the oil markets, and consequential sympathetic gyrations in stock prices, could raise the specter of shenanigans.  Some financial markets players are big thinkers, and will do very aggressive things to make big money.  Regulators need to think as big in order to keep up with them.

The Market Dropped 3%, So What's For Dinner?

On Monday, Oct. 19, 1987, the U.S. stock market nose-dived, with the Dow Jones Industrial Average falling 22.61% in a single day.  That was volatility.

Recently, the market has been bouncing around, losing as much as a few percent a day, and edging into correction territory (a loss of over 10% from the latest high).  This turbulence isn't surprising, given the six year age of the longstanding bull market.  Indeed, in the summer of 2011, the market dropped around 17% on account of various investor jitters.  Then, it recovered.  Markets regularly have downturns, even bull markets.

So what does the future hold?  Nothing that anyone can reliably foretell.  The direction of the financial markets today is determined first and foremost by central bank policies.  The key players are the U.S. Federal Reserve, the European Central Bank and the Bank of China.  Predicting central bank policies is difficult in the best of times.  These days, with the data unusually uncertain, central bank policy is harder to predict than one's luck at the  roulette wheel.  This is especially so since politics appears to infiltrate central bank policy, making prediction even harder.  But one thing you can expect is they'll be cautious about doing anything that isn't accommodative.  If the Fed raises rates in 2015, it will probably do so once, and be done with rate raising for quite a long while.

The Chinese stock markets have a bubbly aura, making further volatility in Shanghai and Shenzen likely.  But China's economy is not heavily dependent on rising Chinese stock prices--and neither are Europe's economy or North America's.  Many individual savers in China are getting hosed, but the Chinese economy doesn't rely on domestic consumption. If Chinese investors lose their savings, Chinese manufacturers will still keep exporting to the rest of the world.  So the acid reflux in the Chinese stock markets may, ultimately, have only so much impact and not more.

Keep an eye on the market, but don't miss any meals over it.  If you're nervous, stay the course and don't invest more right now.  On the other hand, if you're feeling lucky, think about adding a bit to your stock holdings as the averages move down.  You know what they say about not letting a good crisis go to waste.

Is there a black swan lurking?  Maybe.  Since China has been the major source of world economic growth in recent years, any major upheaval in China could be the black swan.  What could happen there?  Well, President Xi Jinping has been aggressively consolidating power.  He may be the most powerful leader China has had since Mao Zedong.  But the market turmoil in China, and the recent slowdown in its economic growth, may be causing some to question his leadership.  The secretive nature of China's Communist Party makes it impossible to know for sure how strong Xi's grip on power may be.  While there are no overt signs of change, if Xi is forced out of power and there is a struggle for control in China, then all bets are off and you might want to do some hard thinking about how much risk you care to hold in your portfolio.

The Zen of Investing

How do you allocate your investment funds in times like these?  Stocks bound upwards for a couple of days when statistical data indicates the economy is slowing or a Fed governor smiles.  Then, the market nose dives crazily the next couple of days when oil prices rise or unemployment falls or another Fed governor frowns.  Bonds slump and then surge, or surge and then slump when inflation expectations rise or fall.  One constant in the financial markets is volatility.  Another is unpredictability.  And a third is no net gains--as in, for all the hysteria, stocks have hardly done squat this year.

The financial media is full of conflicting predictions--the market will boom, the market will crash--and conflicting advice--buy this, sell that, short the world and stock up on survivalist gear.  To paraphrase former Fed Chairman Ben Bernanke, things are unusually uncertain.

At times like this, the best option may be to step back from the chaos and cleanse your mind of desire.  At least, of desire for short term gains and avoidance of losses.  It's impossible to make money all the time, or to avoid all loss.  With entropy seemingly on the increase, any effort to make every day a good market day will have you believing six impossible things before breakfast and doing battle with windmills.

There's nothing wrong with holding cash, maybe even a lot of it.  Cash is beautiful.  A goodly amount in a federally insured bank account or U.S. Treasury debt promotes equanimity and sound sleep.  You will smile more.  There may be some who would argue that a fully invested, well-diversified, periodically rebalanced portfolio will provide better returns than a partially invested portfolio with a lot of cash.  This may be true in theory, but an awful lot of investors don't have the nerve to stay the course with a fully invested portfolio through the periodic mania of the markets.  They sell and freeze up, never again to invest, and potentially lose a great deal of future gains.  All the nice theory in the world doesn't amount to diddly if you're too stressed to implement the theory.  To maximize returns in real life, you have to be calm and unemotional.  And if doing that takes having bundle of greenbacks under the mattress, then so be it.  Don't feel the need to allocate every last dollar to something or other right away.  Hold off on betting your last buck until you feel comfortable.  Be zen, and increase your chances of becoming rich.

Artificial Intelligence in the Stock Markets

Artificial intelligence has been much in the news recently.  Well-recognized deep thinkers have propounded profound thoughts that predict good and bad outcomes for artificial intelligence as it becomes ever more of a reality.  The takeover of the world by machines is inevitable--with monstrous consequences--or not, depending on who you ask.

There isn't much real-world empirical data relevant to the opposing sides of this argument.  But one big clinical trial is underway:  in the stock markets.  Most of the trading done today in the stock markets consists of computerized trading.  Institutional investors, like mutual funds, pension funds, and so on, comprise most of the rest.  Mom and Pop, trying to invest a few nickels for their retirement, are like pedestrians surrounded by massive semis barreling along at interstate speeds.

Much of the computerized trading is done by dynamic computer programs.  In other words, the computer doesn't buy and sell based on a static algorithm embodied in the program coding.  The program can change itself in response to market conditions and activities.  In essence, depending on what the program detects is happening in the market, it can alter its own coding without the need for a human programmer to keypunch and proofread line after tedious line of code.  The details of how these dynamic programs work are generally shrouded in commercial secrecy.  But we have a situation where computer programs take note of what's going on in their working environments, think about how to change themselves to be more effective (i.e., profitable) in light of changing conditions, and then alter themselves to do better.  That's getting rather close to what people do: try to change and improve themselves in order to advance their careers or make more money in their professional activities.

We have seen in recent years how computerized trading can cause mini-crashes and other short term  turbulence in the stock markets.  Mom and Pop are often finding the waters too rough, and suddenly see the virtue in the paltry returns of passbook savings accounts or certificates of deposit whose yields have been flattened by the nearly supine yield curve.  Even some professional money managers are looking for ways to fly over or around the storm clouds of computerized trading, moving trading to venues that claim to allow only "natural" (non-computerized) investors to participate.

For academic researchers and other prognosticators, the dynamic computerized trading in the stock markets could furnish a useful body of data with which to work.  The rest of us, unwilling guinea pigs in a clinical trial we didn't sign up for, can only look to financial regulators and other government officials to ensure that the results of the experiment don't turn out too badly,

Oil Prices: The Next Test For Central Bankers

Most of the benefits of falling oil prices are obvious.  Consumers, whose median incomes have been falling too, are fist bumping over lower gas prices.  Businesses are seeing some energy costs fall, burnishing the bottom line.  Members of Congress, who aren't doing jack about stimulating the economy anyway, can breath a sigh of relief over the economic stimulus from the gas pump.

Falling prices, however, have downsides.  Today, the stock market tumbled because energy stocks are under stress.  The more vulnerable oil producing nations might default on their sovereign debt (think Venezuela, and maybe others).  Many oil frackers are heavily leveraged, and they could start defaulting as their cash flow sputters.  Some financial market players are surely taking losses on falling currencies of many oil producing nations (the ruble being Exhibit A).  More opaquely, but perhaps of great concern, big banks, hedge funds and other financial market players might well be taking losses on derivatives contracts bets linked to the price of oil or the currencies of oil producing nations.  With oil price losses approaching the 50% level in the past few months, it looks like we have a bursting bubble on our hands--and the potential for another financial crisis.

Recall that it wasn't falling real estate prices alone that triggered the 2007-08 financial crisis.  It stemmed from a poisonous synergy of massive quantities of poorly underwritten mortgage loans, falling real estate prices, defaulting mortgage borrowers (many of whom didn't have the ability to repay the loans, measured by any reasonable standard), a compounding of the losses because falling prices precluded the availability of refinancing, the massive impact of these losses on the financial system through diverse and obscure derivatives contracts not well understood by market players and regulators, and, ultimately, a surprising concentration of losses onto a single entity (AIG-Financial) to which numerous key players in the financial system had unmanageable exposures.  Only an unprecedented bailout by the federal government prevented the collapse of the world financial system.

A sharp fall in oil prices doesn't necessarily mean the financial system is at risk.  There was a proportionately larger oil price fall in the middle of the 1980s which didn't result in a financial collapse (although this occurred before the evolution of complex derivatives markets that allow risk to metastasize with blinding speed).  Another big drop in oil prices in 2008-09 also didn't tip the big banks into bankruptcy (although they were already in major bailout mode by this time because of the mortgage crisis, so this instance may not prove much). 

But the proliferation of risks created by today's highly imaginative financial engineering can mean that any major drop in the price of a key asset like oil could surprise us in unpleasant ways.  One lesson from the 2008 financial crisis is that regulators didn't know where the hot tamale would land, until it hit the fan.  Regulators worldwide should be sending their examination SWAT teams into the major money center banks and other key financial institutions to scope out the direct, secondary and tertiary impacts of falling oil prices.  And that should be now--as in right now--not weeks or months from today when it may be too late to take protective action. 

Easy Money: Reinvesting Dividends

Some of the easiest money comes from reinvesting dividends.  Over long periods of time (such as 20, 60, or 80 years) dividends accounted for a little more than 40% of total stock market returns.  Stated otherwise, if you spent dividends, as opposed to reinvesting them, your portfolio would have enjoyed only a little more than half the return it could have gotten with reinvested dividends.  Remember that reinvesting dividends has a compounding effect, and compounding is very, very good for your net worth (see http://blogger.uncleleosden.com/2009/09/if-you-love-compounding-compounding.html).  Your total return can be greatly magnified with compounding, accounting for well over half the long term return.

It's easy to reinvest dividends when you invest in mutual funds.  On the account opening form, just check the box for reinvesting dividends and interest, and the mutual fund's administrator will do the rest. Dividend reinvestment plans (DRIPs) offered by the company issuing the stock are clumsier, since you have register with the company and the shares are less liquid (not so easily sold).  Some brokerage firms will reinvest dividends received in your account.  However, you may not have from DRIPs or brokerage accounts the diversification that offers a reasonably steady flow of dividends.  The easiest way to reinvest dividends is through mutual funds (make sure you choose a fund with low costs).

You'll have to pay taxes on the dividends if they're held in a taxable account (although possibly at a lower rate than what you pay for ordinary income).  If your investments are in a tax-sheltered account like a 401(k) or IRA, dividends will be reinvested as a matter of course and you'll pay taxes when you withdraw the money, or convert or transfer to a Roth account.  For money from tax sheltered accounts, taxes will be assessed at ordinary income rates.  But taxes are imposed on dividends even if you don't reinvest.  So they're don't really affect your decision whether or not to reinvest.

Reinvesting makes money for you while you're sleeping, cooking dinner, playing golf, mowing the lawn or indulging in more screen time than you'd ever allow your kids.  Don't pass up this chance to make easy money. 

The Next Market Bubble

Bulls and bears alike wonder when the next market bubble will emerge and pop.  In recent years, major stock market downturns have come from bursting bubbles.  Recessions, threats of war, terrorist attacks and other disturbances have caused market ripples.  But the big gut wrenchers--the nosedives that wrecked your retirement--have come from the popping of asset bubbles.  The gross over-valuation of tech stocks in 2000, the ridiculous real estate lending of 2005-07, those are the events that clobbered equities.  What does the future portend?

Today, the mess in the Middle East grips our attention.  Medieval atrocities by the Islamic State, a mosh pit with weapons in Gaza, mind-numbing slaughter in Syria and sectarian strife in Iraq appall and fascinate.  But none of them will significantly drive down stock valuations.  They just don't have the economic impact.  The Ebola epidemic is now raging out of control in West Africa.  But America's economic exposure to West Africa is miniscule.  And the disease isn't likely to present a major threat to the industrialized world.

Is there an impending market bubble that could burst and dynamite the world's financial system?  The answer is maybe, in Europe.   The European economy is slowing.  Growth is seen only on alternating Sundays.  The EU stays afloat on a cushion of sovereign and bank debt--a lot of it.  With Europe's slowing economy, it will be tough to pay down this debt and expedient to refinance by issuing even greater amounts of debt.  Risks to larger members like Italy and France are rising.  The EU is a financial and currency union without a unitary government.  Thus, it is tailor made to borrow in bulk without governmental controls to interfere.  We in America know from the 2007-08 mortgage crisis what happens when you bulk up on debt that can't be easily repaid.  The vast amount of European debt presents potential systemic risk, just like the vast amount of American mortgage debt outstanding in 2007.

Exacerbating Europe's problems is the war between Ukraine and Russia.  As Russia's direct involvement in combat is becoming increasingly clear, the war is likely to have ever greater impact on Europe.  Sanctions by the West will probably be heightened, and Russia's retaliation will likely hit Europe harder than America.  Europe's financial system could begin to totter as the EU is pushed into recession and capital flees the Old World.  (Indeed, part of the buoyancy of U.S. stocks can be attributed to the arrival of capital now fleeing Europe.)  A run on the Euro could be the straw that breaks the bubble's back.

The European Central Bank, as always, does a fan dance about how accommodative it will be.  While it's become much more interventionist in the past couple of years, it remains constrained by its anti-inflation charter and the stolid, ever-frowning Germans. Maybe the ECB will save the day.  Or maybe not.

Europe's economy, as a whole, is larger than America's.  A tummy ache there could affect the rest of the world.  if you're worried about where the next bursting asset bubble could come from, keep your eye on Europe.

How To Reduce Volatility in Your Retirement Income

The S&P 500 has dropped three days in a row, and after all the market calm of recent months, many investors must be thinking that the apocalypse looms.  There are understandable explanations for the recent downdrafts.  Islamic radicals of the Sunni variety have rapidly seized several towns and cities in Iraq, along with American weapons and vehicles provided to the Iraqi government (and the administration worries about giving small arms to moderate Syrian rebels?).  Iranian paramilitary troops, who are Shiites, supposedly are fighting alongside Iraqi government troops to retake territory seized by the Sunni radicals. Is Iran now a more important ally of the Iraqi government than the U.S.?

Russian tanks have reportedly rolled into Ukraine, where the fighting is escalating.  Bashir Assad is winning in Syria, and the moderate rebels that the U.S. supports seem to be almost inconsequential.  Most of East Asia is squabbling over this island or that, with contending nations issuing many a proclamation declaiming a neighbor as a ratfink, a double ratfink or even a triple ratfink. 

Domestic politics also create uncertainty for the markets.  Eric Cantor, House Majority Leader, was just defenestrated in a primary election by a guy from far right field whose name, even if we mentioned it now, you probably wouldn't recognize.  (But we're going to, because it's Dave Brat, a marvelously fitting name for a guy who ousted the Majority Leader.)  Cantor, who outspent his opponent's six-figure campaign by $5 million, convincingly proved that money isn't everything.  Not even in politics.  The Koch brothers must be scratching their heads about what checks to write next.

The markets will always be plagued by volatility.  And it tends to pop up when you least expect it.  That might be inherent in the definition of volatility, but you know what we mean.  Yogurt happens, but you don't want your retirement finances smeared with yogurt.  While there are no complete protections against the ups and downs of life, here are a few ideas for calming the financial waves.

Build Up Social Security Benefits.  Disregard the hyperbole.  Social Security will be there when you retire.  Maybe not exactly as it is now, but nevertheless in a meaningful form.  Any politician who votes to eliminate or sharply reduce Social Security retirement benefits will end up doing an Eric Cantor faster than Eric Cantor as voters reject the idea that they should have to eat dog food in their old age.  Work as long as you can to build up your benefits.

Get a Pension.  If you're lucky enough to get a pension, stick out it long enough in that job to qualify.  Although classic defined benefits pensions are usually found these days only alongside the remains of diplodocus, lasso one if you can.  Other pension arrangements, like cash balance plans, are a lot better than no pension. 

Save More.  Saving more is a salve for portfolio instability and financial insecurity.  Those that have the saving jones won't have to get loans.

Use Retirement Accounts.  Retirement accounts like 401(k)s, IRAs and so on offer tax advantages that let you leverage your retirement savings, while limiting your ability to prematurely spend your savings.  A particular advantage to a 401(k) account comes if your employer provides a matching contribution, which is the freest money most people can get.  Use these accounts as much as you can.

Diversity Your Investments.  The values of all assets wax and wane.  But they usually don't wax and wane in unison.  More commonly, some assets get yeasty while others do the fallen souffle thing.  And vice versa.  So a diversified portfolio is usually kind to your antacid budget.  There are moments, like the 2008-09 financial crisis, when it seems like almost all assets belly flop.  But these cognitively dissonant interludes are the exception and not the rule. 

Consider an Annuity.  A fixed annuity (one that pays a specified dollar amount per month) or a fixed annuity adjusted for inflation can be a reasonable way to provide a steady income.  Annuities aren't cheap, and you should buy only from an insurance company with a strong credit rating. Don't put more than about one-third to one-half of your portfolio into an annuity because cash needs in old age can be unpredictable and it helps to have a nice pool of cash or cash equivalents.  Be very cautious about variable annuities--they often have high expenses, and the point here is to reduce volatility, not subject yourself to it in another form. 

Health Insurance and Long Term Care Insurance.  Financial volatility can sometimes come from sudden increases in expenses, and not just decreases in portfolio values.  Health care and long term care needs are the biggest landmines in the journey through retirement.  Most retirees are covered by Medicare, but if you're not, then buy something else.  The Affordable Care Act, despite all the teeth-gnashing on the right, is likely to be a good option if you don't have anything else.  If you have a significant net worth, consider buying long term care insurance, especially if you have a spouse who may depend on that net worth after you've gone to the great Dance Party in the sky.  It's expensive, but so is long term care.  If you want more than the quality of care given to Medicaid patients, long term care insurance may be a good choice.

Part-time Work.  Okay, you want to hear about retirement, not employment.  But part-time employment reduces the extent you need to draw down your savings, so you can keep more powder dry for later.  It also lessens your risk of dying from the boredom of day time TV.  It may boost your Social Security benefits (depending on your work history).  And the dignity of work is better than the indignity of looking for sales on dog food.

The Shrinking Deficit: a Plus for the Market

The federal deficit is projected by the Congressional Budget Office to be just under $500 billion this fiscal year (the year ending Sept. 30, 2014). (See http://www.cnbc.com/id/101581648.) That's a lot of money, but only one-third the deficit of five years ago.  In other words, the deficit is lower by a trillion dollars, compared to half a decade ago.  That's a whopping huge drop, which leaves this year's deficit at 2.8% of GDP, below its historical norm of 3%.

When deficits fall, the government competes less in the credit markets against private sector borrowers.  This makes it easier for private interests to secure investment capital, a key predicate to economic growth.

Stocks tend to rise during periods of falling federal deficits.  The late 1940s and the 1950s are one example.  The 1990s are another.  The fact that stocks have risen steadily from their 2009 lows indicates that we are in another period of falling deficits and rising stocks. 

The future direction of the deficit is unclear.  The CBO predicts that it will fall a bit more next year and then begin to rise.  However, five years ago CBO didn't come close to predicting the deficit reduction we now have.  The weird, dysfunctional cognitive dissonance that is today's federal governance somehow managed to produce this beneficial result.  Who knows whether it might stumble its way to more good outcomes.  If the deficit stays moderate (near 3%), the markets will probably benefit.  While there are many other factors fueling volatility today, the federal deficit, improbably, isn't one of them.

When the Market Will Go Down Next

With the stock market having more than doubled since its 2009 low, the question on the table--just about every investor's table--is when will the market turn down?  Recent trading days give us a likely answer.

For the past three trading days, the market dropped sharply as momentum stocks had bad momentum days.  Today, the market rallied briskly when the Federal Reserve released notes of its most recent open market committee meeting, indicating that central bank accommodation is alive and well.  Sweeter words could not have fallen on the market's ears, and stocks rejoiced.

As long as the market has confidence in central banks, there won't be a major downturn.  If the market senses that central banks are losing control, watch out.  Corporate earnings matter for individual stocks.  But central banking is the key to the overall direction of the market.