Earlier this month, Gallup released data it collects concerning stock ownership in the United States. The data show that stock ownership among Americans is at its lowest point since Gallup began tracking the data in 1998 with just 52% of American’s surveyed claiming to either directly or indirectly own stock in a public company.
Historical data from Gallup shows us that American stock ownership peaked around 2007 at 65% reporting direct or indirect ownership in stocks, and this percentage has been on a consistent decline since. Not surprisingly the sharpest declines in ownership took place during throughout 2008, but somewhat counter-intuitively—or at least that’s what some experts would have you believe, the trend continued in the same direction despite what has become a pretty good market rally since the 2008 fallout.
Is this a sign that it’s time to get back in?
I Remember When…
I remember when stock ownership was a badge of honor. When discussing your stock trading strategy meant you were a somebody and everyone wanted in. A day when discount brokers held the key to the gate to let us all into the magical word of riches and all we needed was $500…and maybe a subscription to Barrons.
I also remember a time not longer after the turn of the century when people started to admit that maybe just maybe they wrong about the whole you-can’t-lose-money-on-the-stock-market thing. Maybe it wasn’t an elevator with a broken down button, and maybe just maybe you had to be careful out there.
Once we rolled into 2003 and every home owner in America realized they could attach a credit card to the difference between what they owed on their mortgage and this magical number they foolishly thought they could command if they decided to sell their house, which by the way would increase by at least 8% annually for as far as the eye could see, the gloomy days were over and it was time consume, consume, and then consume some more.
And consumption is good for the economy. Ask any economist you want to. They’ll tell you the prevailing function for GDP is C + I + G + NX, where C is consumption, I is investment in the economy, G is government spending, and NX is the net result of exports minus imports. So if C increases, GDP increases providing everything else remains equal.
From a an aggregate supply and demand point of view, increasing demand (more consumption) pushes prices up, enticing more suppliers to enter the market, so it’s stands to reason that higher consumption will also spur investment, meaning even better GDP. Oh happy day, those mortgage backed Amex’s (heh) are a real boon for the economy!
But what Happened?
How could this complementary compounding appreciation on the right side of our equation come to a screeching halt? Well, it turns out that when you indebt yourself in perpetuity the party, like all parties, will eventually face a sobering morning after. And all theories to the contrary, even those postulated by former Fed Chairman Greenspan, appear to fall short in their suggestion that it only requires a willing counter-party to “consume” your debt, or perhaps more appropriately stated, the counter-party will become much more worried about your out of control spending much sooner than you will.
Worse yet is when everyone figures out that the collateral you pledged for the loan was propped up on a nearly scandalous valuation. In other words, your collateral doesn’t cover your outstanding loan and you face one of the most frightening financial phenomenons known to mankind. A triggering event that took down two of the oldest and largest investment banks in the United States, a margin call.
On their own, margin calls are not necessarily an event worthy of sending shivers down your spine. But when you’re faced with a liquidity crisis (i.e. you ain’t got no money) a margin call is game over.
Much of the last decade was, in my humble opinion, a saddening attempt to move the peg back to the world we knew throughout the 90’s. A time when the stock market was king. Regretfully the fundamentals weren’t there. And I’m quite confident when I suggest that they won’t be anytime soon.
This isn’t a call to forsake the stock market. Though I think a lot of people can do just fine by limiting their exposure to it, I also believe that it’s a useful tool for enriching your overall networth, as long as you understand the rules. There are two essential understandings you must have when it comes to the market:
- Buy and hold is not a method for beating the market. And that’s okay because the market will probably putter along at an agreeable rate that will still enable American’s to save money, though they desperately need to adjust their expectations.
- There is money in the trade. I’ve said this before and I’ll say it again. Plenty of people make money, serious money in some cases, by trading in the stock market. It’s not easy, it involves a high degree of risk and attention to detail, but it’s totally doable. You can dedicate a significant amount of time and resources to trying to figure it out yourself, casually place a few bets and hope they pay off, or pay a professional about 2% of your account balance and 20% of the annual earnings to do it for you, and in most cases he or she will deliver.
Outside of this you’re unlikely to experience some major windfall by investing in the stock market because you got lucky with your 401k elections. It might happen occasionally, and occasionally someone places the right bet at the blackjack table, too. Doesn’t mean you and I will.
Are People Really Running away from the Market?
Sure some are. And there are plenty of people out there who have decided they don’t trust the stock market. And the statistics certainly show a gloomier outlook on Wall St than we’ve known to be the case in the past. But I’ve long suggested that stock ownership’s decline is less about outright fear, and more about fundamental prudence that we’ve known about all along. And none of what I have to say hasn’t been said before, in fact it’s has been discussed for at least the last two decades.
Modern Portfolio Theory has the Answer, and it’s a lot Simpler than you thought
According to Modern Portfolio Theory, risk exposure should decline as one ages because they are reaching a point where they need their asset account balance to be more stable. As a result, the common macro move here is to move out of assets like stocks, and into assets like bonds.
This suggestion is due to the implied risk differential between bonds and stocks (i.e. stocks risky, bonds safe). Not surprisingly, people also tend to substitute stocks with bonds when they feel the stock market is being unpredictable. Putting the discussion about the often overlooked risk aspect to bonds (especially now) aside, let’s think for a minute about the notion that bonds are an economic substitution for stocks on a basis no more complicated than the simple stocks risky/bonds safe paradigm.
Remember the elementary lesson in economics concerning supply and demand. Inceased demand will push prices up if supply does not equally follow the shift and increased supply will push prices down if demand does not equally follow the shift and vice versa.
For years, we’ve seen the stock market rise, but is that because the economy was booming? Not really. Sure we didn’t do badly, GDP grew from 1980 through 2012, but a little less than 3% per year. But that’s a far cry from growth in the S&P 500 which grew 11.24% year over year. Woohoo let’s buy some stocks, or maybe not so fast.
Supply and Demand, it Affects Stocks, too
The boom in the stock market is likely a function of several factors that seem way more boring, but extremely important than one might assume. But ultimately the explanation behind the market rocket ship over the last several decades is simply a function of supply and demand. We had the introduction of retirement plans that strongly favored stocks as a funding mechanism, the evolution of a distribution market for stocks that helped create increasing demand, and the movement of a bloc of population that reached its pinnacle for stock ownership. All three of these variables have now matured, and barring any new evolution to retirement options, or distribution models, it’s unlikely the demand will be sustained.
But what about that last variable I mentioned? That group of people we know more commonly as the Baby Boomers are heading into retirement. And that move is a corollary with a shift to less risky investments. Modern Portfolio Theory itself can explain why stock ownership is on the decline and why demand for stocks is trending down. And I’m not the first one to mention this. In fact Ken Dychtwald started this conversation nearly three decades ago with his book Age Wave.
”Bad” New For Stocks
The bad news is that choppiness in the markets is likely here to stay—and probably a bit of a self-full filling prophecy as people trade emotionally and ergo irrationally in a hope that former happier days will return.
The good news is, Americans haven’t really forsaken the stock market (the stock brokers can all breathe a collective sigh of relief) but there will most likely be a shifting trend away from stocks moving forward, and this doesn’t play so well to the former paradigm we established through the 1990’s.
More Bad News, Interest Rates
I’m sorry to buck the trend here a bit, but Ben Bernanke isn’t the only guy responsible for low interest rates. I’m afraid grandma might also be partly to blame. Just like everything else, interest rates are affected by supply and demand. And the interest rate market is essentially the money supply/lending market.
As money shifts out of stocks and into bonds as per the rule of thumb do-it-yourself MPT portfolio allocation would suggest, there’s a large wave of liquidity injected into the market place. We’ve observed this trend as equity mutual funds have experiences pretty substantial net outflows over the last several years, while bond mutual funds have enjoyed strong net inflows.
This shift puts downward pressure on interest rates as more plentiful money supply for lending means money is cheap and looking to be put to work.
The additional frustration this creates for the debt investor is the fact that worthwhile yields will be tougher and tougher to come by. The solution is quite tough. We need to kick demand for money (borrowing) into hyper-drive. But that won’t be easy in an economy still hung-over from a lending binge that spanned an entire decade plus a few years. Macro investment is the most obvious answer, but how you get a business to borrow money if it has no plans to actually use the money is a tricky proposition (they teach the MBA kids not to do that).
The most appropriate answer, sit down and be prepared for low interest rates for what will likely amount to a much longer period of time than originally assumed. The good news is, those in a position to borrow, may pull off some really impressive return on equity. Good for them, bad for everyone else who just wants to park their money somewhere for a decent and reliable return.
What’s Old is New Again
There’s much said about an America that returns to more earlier half of the last century style behavior. Where thrift trumps materialism. For an economy well established on the back of the retail industry, this calls for a major shift in focus and norms.
It’s also forces all of us to re-evaluate the way in which we approach investing and financial planning. And I’d suggest it’s not a time for complaining about how good things used to be, and instead find fruitful strategies within the new paradigm. Stock ownership will probably continue to slide a bit, and most stay blah when compared to the last couple of decades. That doesn’t mean there is no market there for an investor, it just makes navigating it a tad trickier.