I woke up this morning to news of shock/horror – various stock markets have taken a tumble! Oh the humanities! As always when there is talk of economics I have three smart folks to which I turn, all of whom are on my sidebar. Today it is Aaron Clarey who has some great observations on why this little dip is a good thing.
Clarey makes some great points here. Chief among them, and something which is crucial for anyone who wants to gain wealth, is the fact that buying shares in the hope that their value will appreciate is not an investment – it is pure speculation. So for all the speculators out there, which is undoubtedly the vast majority of people who throw money at the stock market, this news is terrible indeed.
(Although for canny speculators it’s not bad at all: the real time for a bit of speculation is to buy stuff when everyone is selling and the price is going down. Two fantastic examples of this were the 8 hours that followed the announcement of the Brexit vote and Trumps win; stocks dived not because they had lost their perceived value but because people had collectively lost their minds, which is what is known as a buying opportunity.)
In order to invest in stocks you need to gain a return, (selling the stock is not a return on an investment – it is a return on speculation). To gain a return from stocks you need to get paid dividends on the stock. As Aaron points out, present dividends average 1.7% which is not worth the risk. The more the stock market inflates, the more that dividends go down because there is too much easy money floating about. Conversely, when stock markets contract then the dividends go up.
More importantly, as dividends are paid per stock then it follows that the more stocks you have then the more dividends you can get paid. If the stock market collapsed by 50% just think of that as a 50% off fire sale on purchasing stocks in order to earn your dividends.
You invest in this way with the hope that over the course of its life the investment will pay off more than what you initially invested in it. You sacrifice the money you invest now in order to gain over a long period of time. Of course we live in a society that believes in living in the moment and which values fleeting pleasure over thrift and sacrifice so if you do this then you’ll be going against the grain; in itself also a good measure to ascertain whether something is a sound idea.
Old Remus also has some words of wisdom today on the natures of stock markets.
When I was in the market, at the penny ante level mind you, a year without a substantial correction was remarkable. Not only are there investors who’ve not seen such a routine correction, there are brokers who’ve not seen one. Monday’s drop was something over 4%. For the last five days it’s -7% or -8%. In years past it would get people’s attention but that’s about it. What did they expect with the Schiller P/E above 30?
A classic 1929-style crash starts with a deep, fast decline. Then comes a recovery of about half the decline, which draws in “buy the dip” investors, fresh meat for the monster ahead. It’s a quick gulp of fresh air before the real crash begins, the Big One, stair-stepping down for a couple of years until it bottoms at a small fraction of the peak, exhausted and depleted. While this probably isn’t the Big One, it could be the initial fracture, or it could be something like the -21% quick correction of 1987.
One last thing, and only partially related: over the past year whenever I have heard Trump glorify in and seemingly take credit for the booming stock market I have winced a little inside. Governments are not stock markets; the stock market is a reflection of business activity and governments have no business being in any business. They don’t have any business being in the economy either but that cat is now totally out of the bag.
The problem with an administration taking credit for the performance of such an indicator when it goes up is that by default that means that they have to take the blame when it goes down. By all means Trump should take credit for passing the tax cuts which then caused more business investment in the USA and for bonuses paid to workers as a direct result. But the best attitude of any government as regards to the economy should be that of getting out of the way as much as possible and then it’s up to you guys. I fear that this oversight and hubris will come back to bite Trump in a big way.