From Jim Strickland: “I’m confused about the stock market. The most simplistic explanation I’ve ever heard for what the stock market is, is that it is a way for you to own parts of companies. [A.T.: A perfectly good explanation.]
“In the old days, before 1987, hardly anyone invested in the market or cared about it much, so there was always this finite, slowly growing, amount of money being invested. This was perhaps the reason stock prices also rose ‘slowly,’ 10% a year or so. [A.T.: Stock prices tended to rise 6% or 7%, plus there was a thing called dividends that added another 3% or 4%, for a total of 9% or 10%.]
“But since 1987 a number of things have changed.
- The baby boomers are saving like crazy. [A.T.: No, but we should be.]
- 401 K plans are hot because NO ONE trusts a company to give you a pension till your 100. [A.T.: And because where an employer puts up 25 or 50 cents for each dollar you save, NOT to save is like spurning FREE MONEY.]
- The tax code has been tightened up so there aren’t many loopholes for people to put their money in, so it goes to the market.
- The whole world trusts the U.S. economy more than any other, even their own, so that money is coming over.
- Inflation is way down so bonds aren’t very fun anymore. [A.T.: Low inflation isn’t what makes bonds no fun. Real interest rates – the rate you get after inflation – are higher than they were when inflation was high. But bond interest is heavily taxed, and how can they compete for fun with stocks that go up 25% a year? They will be much more fun in a year stocks go down 25%.]
“So if you look at all of the above points, there is TONS more money coming into the market, trying to buy the same amount of shares, companies, etc. I know that’s not exactly true but for arguments sake it’s true enough. So all the money in the world chasing the same amount of stocks will of course drive the prices higher constantly, no matter what else happens. This is what I believe is happening to stock prices.
“It seems to me that one of two things can happen. Either …
- This is the way things are going to be from now on and it’s ok, don’t worry about it. Or …
- This is like what happened to Japan and the stocks are going to fall like crazy sometime, half the ‘wealth’ of individuals is going to ‘go away’ and we’re all in for a really lousy time.
“Are there any other ways to use investment money besides putting it into stocks and carving the same pie into smaller pieces?”
A.T.: I think you’re not a bit confused, Jim [my annoying bracketed comments notwithstanding].
As high as our market has gotten, its overvaluation (if I’m right that it’s overvalued) is nothing like Japan at its peak, and I’m hoping it won’t be. But you’re right: If people just keep bidding up prices irrespective of value, prices will keep going up irrespective of value – but not forever.
Other places for money? You bet. I’m not recommending these, just listing them:
- Paying down debt. Want to suck a trillion dollars in demand out of the stock market? It’s as simple as people deciding to take profits and use them to pay down their mortgages. (Even just paying off car loans would suck a little liquidity out of the market, and an investor who does that earns 10% risk-free, tax-free if his Buick came with a 10% loan.)
- Real estate. Suck out some more demand buying a retirement condo or bidding up the price of land. If you had a $30 million profit in some high-tech stock, what would you care whether you paid $1 million or $5 million for your Caribbean island? For your view of the Tetons?
- Bonds and cash. The Japanese have invested a ton of their own money in U.S. Treasury securities. At some point, American investors might decide to bid up their prices and buy them back. Or just to put more money into safe bank accounts.
- Overseas. Lots of markets are high, but some are not. Some people may decide to switch a bit of their assets from the U.S. to Asia or others areas.
- New investments. One of the great things about this low-interest, liquid investment environment is that it leads to financing tremendous innovation. We’re building a new economy, here and abroad – so one place the new dollars can flow isn’t into existing shares of existing companies, but into new shares of new companies. There’s a limit to how much can be wisely invested, but a growing world economy will definitely absorb investment funds. What will it cost to bring the rest of the world up to US/European standards of living – and to do it in planet-friendly ways? There is a tremendous need for capital, if only the economies of the world can figure out how to organize it all with reasonable good sense.
So, yes, there are places those trillions of baby boom dollars could go other than the high-multiple U.S. stocks.
(One other place: the doggy stocks that, even in this market, are too small or dull or unappreciated to have gotten swept up with the rest. Forget the dogs of the Dow. You should see the dogs of my Keogh.)