The biggest lies on Wall Street

Feb. 22, 2013, 12:18 p.m. EST · CORRECTED

The 5 biggest lies on Wall Street

Commentary: These market myths are doing the rounds — again

 

By Brett Arends

Fixes label on corporate debt chart.

Reuters

The Dow popped back above 14,000 this week. The market’s been booming all year. Small cap stocks just hit a new all-time high, and Mom and Pop have been jumping back into the market.

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Don’t mind me. I’m sitting in the back of the theater, throwing popcorn at the screen and shouting, “Boring! We’ve seen this already!” Maybe I’ve just been to too many movies.
Like this one.
Maybe the Dow will double from here. Maybe the good times will roll.
But don’t spin me. Here are five myths about the stock market that are doing the rounds, yet again. They just don’t seem to die.
Stocks will do well because U.S. corporations are in great shape.
Well, some of them have a lot of cash in the bank. So what? They have a lot of debt, too. According to the Federal Reserve, the total liabilities of U.S. nonfinancial companies just hit a new, all-time high of $13.9 trillion. That’s up 40% from a decade ago.

In other words, they owe about the same amount as the federal government. They’ve borrowed more than a trillion in the past three years alone.
What? You hadn’t heard that? Surprise.
We hear nothing but how deep in the hole Uncle Sam is. Big Business owes about the same. But ... nothing. Not a peep. Ah, if only debts didn’t count. Why, then, yes, corporations would be in great shape. So, too, would Subprime Suzy. Did you miss that movie?
OK, so corporate profits are booming. But that’s not a reason to invest more, least of all when those high profits are already factored into high stock prices. In fact, it’s a reason to be worried.
Profits can’t keep rising indefinitely as a share of the economy. When they go up, they come back down. According to the U.S. Commerce Department, corporations’ after-tax profits as a share of the economy have been at current levels only a few times in the recorded past. Like in 2006. And 1967. And 1929.
Ah, good times. Miller time!
Stocks will do well because the economy is recovering.
And so it is! But so what? That doesn’t mean the stock market will keep booming. From 1968 to 1982 the economy grew nearly 300%, but during that time, the stock market went nowhere. In real, after-tax dollars, investors lost money.

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The five biggest lies on Wall Street

MarketWatch's Rex Crum discusses the five biggest lies on Wall Street. Photo: Getty

The economy has grown by two-thirds since 1999. How’s your stock portfolio done over that period? The Japanese economy has doubled since 1989, but the Nikkei is still down by three quarters. Studies by Elroy Dimson and colleagues at the London Business School found many cases around the world of capitalist economies where investors did poorly for decades even while the economy grew.
Economic growth does not always produce good investment returns. It’s a myth.
Stocks should earn 9% a year.
Hooey. By this logic, I should change my name to Michael Jordan: It would make me a great basketball player. Yes, from 1928 through 2011, U.S. stocks produced compound average returns of 9.2% a year, but you can’t just extrapolate that to the future. See: Annual Returns on Stock, T.Bonds and T.Bills: 1928 - Current

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Google shares top $800, giant eyes retail push

Google has plans to launch retail stores in the U.S., while its shares hit an all-time high of $800. Photo: Getty.

First, those numbers include inflation. The returns in real, or constant dollars, was a much more modest 6%. Second, this is just an average. And it’s very misleading.
During all those years, as Stern’s data shows, the stock market only beat inflation by a decent margin during two boom periods — from 1949 to 1967 and from 1982 to 1999. Both were followed by vicious bear markets which wiped out the gains.
If you missed those two booms, your total gain from U.S. stocks over the other 54 years since 1928 came to a grand total of 7%, after inflation.
No, not 7% a year. Seven percent. Total.
A balanced portfolio of stocks and bonds will always make money.
This is more nonsense. I don’t want to reinvent the wheel, so I can direct you to an article I did about this last year. The elevator summary is that the so-called “foolproof” balanced portfolio of 60% stocks, 40% bonds has failed, massively, at least twice, just in the past 84 years — from 1937 through 1950, and from 1965 through 1982. It can fail again. That’s because there is nothing magical about a “balanced” portfolio of stocks and bonds. As people used to say, nothing is ever foolproof because fools are so damned inventive. See: Why a ‘Balanced’ Portfolio May Not Work
A portfolio of bonds and stocks has only worked in the past when either the stocks were undervalued, or the bonds were undervalued, or both. That’s it.
In today’s gerrymandered market, the Federal Reserve has arranged for the 10-year Treasury bond to yield just 2%. That’s half a percentage point per year less than the central 10-year inflation forecast of the bond market. Bonds usually yield about 2% a year more than inflation. Today’s bonds are mathematically designed, with the precision of a Swiss watch, to lose half a percent of purchasing power every year.
These bonds cannot be undervalued. They are almost certainly wildly overvalued. The only circumstances in which these bonds will not lose you money, in real, inflation-adjusted terms, over the next 10 years is if a deflationary crash and depression cause your stocks to plummet.
There are billions of dollars in cash sitting “on the sidelines” waiting to come into this market.
Did you ever see John Carpenter’s “The Thing”? It was a horror flick set in Antarctica.
The monster was a shape-shifting alien that just wouldn’t die. Kurt Russell’s hero hacks it to pieces, but it keeps coming back.
When the creature’s severed head sprouts legs and it resumes its attack once again, Russell says, in disbelief: “You. Have. Got. To. Be. [Unprintable exclamation omitted]. Kidding.”
I know exactly how he feels. I feel the same way I hear someone talk about all the “cash on the sidelines” waiting to come in to the stock market and drive it higher.
You will hear this even from some sensible people. And, curiously, when others criticize the argument, they usually do so on minor technicalities, like that there really isn’t as much cash on the sidelines as people think.
No, no, no. The whole argument is wrong.
In a nutshell: Every time someone buys a stock, someone else sells a stock. If your grandma puts $10,000 into the stock market, someone takes $10,000 out of it.
If I spent $470 tomorrow buying one share of Apple, I’d have to buy it from someone. Before the transaction, I’d have $470 and he’d have one share of Apple. After the transaction, I’d have one share of Apple … and he’d have $470.
Amount that has come “into” the market? Zero.
If you don’t believe me, try it.