Is the market at a turning point? Where do we go from here?

20240311

Stock market theory and practice

The theory of the stock market is something like this. A corporation needs capital in order to buy the land, plant and equipment to produce some product or service. It sells shares in the company to the public.

The cost of the shares is some multiple of the company's annual earnings.  If it is then a mature industry such as automobiles or underwear the company's annual business volume is not expected to grow much. Investing in any company is riskier than putting money in the bank. Such a company might return a 10% dividend – $100 on every $1000 invested. Assuming the company didn't keep any profit for reinvestment, the price-earnings ratio would be 1000÷100 = 10.

Investors have to make some commonsense assumptions. They assume that the bookkeepers honestly record the company's financial transactions. They assume that the company's financial officers report income and expenses, profit and loss honestly. They assume that the external auditors do an honest job of validating the books. They assume that the company adheres to pertinent laws with regard to protecting the environment, using safe ingredients in the products, employment practices and so on. Bearing these risks inherent in these assumptions justifies the gap between the returns on stock market investments and bank deposits.

A company in a new field whose business volume is expected to grow may sell at a higher price-earnings ratio, one that factors in expected future earnings. A company that is in a mature or dying industry, such as tobacco or petroleum, will sell at a lower P/E ratio in the expectation that future business volume will be lower.

Stock market research analysts read company and industry publications and do their best to estimate a company's future earnings and thus compute a fair P/E ratio. They recommend that investors buy when the P/E ratio is below what they think it ought to be and sell when it is too high.

These assumptions have always been overly simplistic, but they used to work better than they do today. The nature of the stock market has changed in significant ways.

As I discuss in this video, companies in the 19th century met real human needs: steamship transportation, railroads, steel, petroleum, electricity and fundamental applications of electricity. The future requirements for such products were easier to project.

In the 20th century the focus shifted to human wants. We craved entertainment – movies and television. We craved comfort – air conditioning and luxurious cars. We craved convenience – washers, dryers, dishwashers and so on. The future sales of things people really don't need was a bit harder to predict. It was more difficult to guess the potential of new products and services such as snowmobiles, professional sports, cruise vacations and fitness centers.

In the 21st century the focus has shifted again, to ephemeral needs that are being hyped by government, social media and other agents. The current stock market darling is Nvidia, the first company to earn $1 trillion market capitalization.  It makes superfast graphics cards for video gamers and is heavily invested in artificial intelligence. Projecting where these industries are going is extremely hard, but they are enjoying a tremendous amount of hype at the moment.

The 21st century also brought us the Covid 19 vaccines, wind and solar power, electric cars and other industries that have been powered by government regulation, government pressure, government investment, virtue signaling via social media and a host of other factors far removed from actual human needs. Human needs were being satisfied, many would argue better satisfied, without these 21st century twists.

The great books on the stock market such as Benjamin Graham's 1949 "The Intelligent Investor" focused on the basics. Investing based on the fundamentals made sense when companies competed in a free market and their business decisions were made in response to market signals. That is no longer the case.

Motivations and mentalities

It is now necessary to analyze the motivations and mentalities of the market players. 

Private Investors

Every private investor professes to be interested primarily in money. But there are differences with regard to how much and when. A 25-year-old investor with a good income is interested in long-term returns. He can afford to invest in speculative stocks such as Amazon and Google. A retiree who simply wants enough income to support him in his declining years has a very different perspective. He wants to own stocks that are not likely to lose value and will provide an adequate annual return.

But people are more complex than that. I for one have moral qualms about owning pharmaceutical, tobacco or gambling stocks. I have passed up the profitable bet on Moderna and Pfizer.

Many investors virtue signal. I know a Tesla driver who named his firstborn child Nicola in honor of the inventor. Many children are being named Elon these days. Such investors are enthralled by Elon Musk's persona. Other investors have rushed into biogas, solar panels, wind turbines and such not whatsoever on the strength of company fundamentals but on the basis of what their friends would think of the investment.

Some investors are competitive.  Others are gamblers. They are not content simply to be making money.  They want the bragging rights that come with making more than anybody else.  These are the people who rush into the next big thing such as Tesla, Theranos, FTX and Bitcoin without understanding anything of their fundamentals.

There are at least standard for comparison with Tesla. Other companies make cars.  Theranos and FTX, like Enron and Bernie Madoff before it, supposedly had some kind of magic in a black box. When skeptics pulled away the curtain there was – nothing there.  Bitcoin is different in that everybody knows upfront that there is nothing there. They just don't know what to make of the fact.

Government decision-makers

The typical civil servant, making decisions on behalf of the government, simply wants to avoid trouble. It worked in our favor when I started to work for IBM in the 1960s.  No bureaucrat could be faulted for choosing IBM. However, sentiment shifted and by the 1970s no bureaucrat could afford to choose costly IBM equipment over competing brands no matter what advantages were to be had. In every case the major considerations were keeping one's job and advancing one's career. No civil servant cared about saving the government's money.

Civil servants enjoy pretty good job security and income. They can almost never be fired. They have quite generous pension plans, vacations, and medical benefits.  Civil service jobs are usually not too demanding – they can moonlight as real estate salespeople or sell insurance.

As noted above, civil servants generally don't care about saving the government money. They are interested in their own pocketbooks. This results in the agency problem – conflict of interest among the people being governed, the government itself, and government's agent the bureaucrat. In just about every case Joe Citizen, the taxpayer, comes in last. There is no mechanism within government to look out for his interests.

In addition to his salary, a government employee is allowed to make private investments. They quite naturally invest in companies that they know about through their work. An employee of the NIH or CDC knows about upcoming drugs and medical procedures. An employee of the EPA knows about upcoming decisions on herbicides or pollutants. A member of Congress like Nancy Pelosi or Diane Feinstein knows a vast amount about how upcoming legislation will affect the profitability of different companies.

Per the Bayh-Dole Act of 1980 government employees can receive royalties on patents they received while working for the government.  This gives civil servants responsible for overseeing industries such as pharmaceuticals incentive to favor companies that will use their patents.  It happened in a major way with AIDS and Covid 19.  See Celia Farber, cited below. Both the media and the government turn a blind eye to this obvious conflict of interest.

Advancement in government service depends on ratings by one's peers and superiors. An examination of the office of personnel management's forms reveals that the criteria are quite opaque. Without a doubt it is useful to have embraced government wide dogmas with regard to diversity, equity and inclusion (DIE) and environmental, sustainability and governance (ESG). A person certainly has to have proven him, her, or itself (watch your pronouns!) to be a reliable team player in order to receive a promotion.

There is always a tight relationship between civil servants working for the regulatory agencies and the executives of the industries they regulate. On the other hand, the regulatory agencies have no connection whatsoever with the citizens whose interests they are charged with protecting. At a minimum there is a lot of backscratching exchanged between the regulators and the regulated. Government employees are well treated at industry get-togethers at pleasant resort locations.

The revolving door takes it beyond that. Many senior executives at drug companies, just to name one instance, came from government. And many senior executives in government came from the drug companies. Bouncing back-and-forth between the private and public sector has benefited many a career.

For an investor, the bottom line is that people in government can actively promote the interests of private companies even when they are at odds with the interests of the public and are unrelated to the company's prospective profitability absent government interference.

Active support from civil servants in regulatory agencies has been essential to the profitability of solar panel manufacturers, wind turbine manufacturers, electric car manufacturers, carbon trading companies, vaccine manufacturers and many others. Ideas that make no fundamental business sense can be highly profitable if the government supports them, which it can do by inventing and greatly magnifying imaginary problems such as global warming and pandemics.

Other players: NGOs, Lobbyists and Media

Private charity has been thoroughly corrupted by big money. Notable examples are the Bill Gates philanthropies, Clinton foundation and George Soros' philanthropies. In addition to advancing the investment interests of their founders, they actively support political agendas.  This has been true for generations. Rockefeller, Ford foundation and Carnegie money has supported liberal causes that one imagines would have been anathema to the people who made the money in the first place.

The morality of the political agendas aside, an investor cannot help but notice that there are investment opportunities in the programs that most nongovernment organizations promote. When Bill Gates' GAVI and World Health Organization "charities" express an interest in vaccines, there is certainly money to be made in the pharmaceutical companies providing them. When NGOs align with NOAA, the EPA and other agencies of the federal government to promote the climate change story, there is money to be made however harebrained and unworkable the schemes turn out to be in the long run. There is money to be made on the downside when things collapse. Germany's wholehearted, half-witted embrace of solar and wind energy is turning out to be a disaster. That bodes profits for alternative sources of energy – nuclear and dirty old fossil fuels.

The media depend on advertising for their revenue and government for permission to operate.  Being indebted to them, they have supported government, big pharma and academia.  Hence the dramatic drop in faith in the mainstream and the rise of independent media.

Recognize that Government drives private sector investment decisions

It does not make sense to have civil servants perform real work except when there is no alternative.  They are not efficient. They don't have a profit incentive.  They cannot be let go when a particular job is completed.  It is more economical for government to contract for complex undertakings such as building weapons systems, computer systems, roads and bridges.  It can be more efficient even for tasks like policing, running prisons and delivering mail.

Weapons manufacturing is almost all done by contractors.  Government contracts have been a great source of revenue to a great many other technology companies.  Oracle powered government databases.  Cisco provided the hardware backbone of the Internet.  Google provides translation, map and other services.  Amazon provides cloud services.  And, of course, they all answer the call when the government wants them to spy on the citizenry or promote its many agendas.

We see the consequences when companies do not cater to government wishes.  The government did its best to avoid giving contracts to IBM and sued to break it up in the 1970s.  Bill Gates in the 80s was initially reluctant to get in bed with the government but soon came around.   Elon Musk seems at this writing to be showing a dangerous level of independence. 

Since the government depends on the private sector to provide arms, it assures that the defense industry is generally profitable.  It depends as well on technology companies for state-of-the-art spyware, cryptography, data storage and transmission.   Elon Musk has recently demonstrated how much more efficient the private sector can be in rocketry and satellite communications. 

Once the government favors a company, investors flow in.  I became interested in Oracle  and Cisco as that happened  in the 1980s.  Fortunately, those companies satisfied real needs with well-conceived products.  In the 21^st century the government has favored companies whose products addressed hypothetical, unreal problems such as global warming and the dangers of nuclear power.  Stocks in those fields also rose as investors flowed in. 

The elected legislators and civil servants in regulatory bodies are the first to know which way the wind is blowing.  As an example, 5G wireless does not satisfy any compelling need, and there is increasing concern that electromagnetic radiation poses health hazards. 

The EPA, FDA, FCC and other regulatory bodies were asked to consider potential health hazards in the process of approving this new technology.  Employees of the regulatory bodies knew before anybody else that they would be approved and could predict how profitable they would be.  The same kind of thing happened with the "safe and effective" injectable biological products rolled out to fight Cоvid 19.  Government employees likewise would have been able to profit from inside knowledge about banning Monsanto's glyphosate, approving Bitcoin ETFs and other such events.  It is a conflict of interest to trade on insider knowledge, but it happens all the time.  Other investors, watching what the insiders are up to, can profit alongside them.

Manipulating perceptions

Throughout its history the government has shown a strong interest in the price of gold. Franklin D Roosevelt outlawed private ownership of gold in 1933 at the same time he reset it from $20 to $32 an ounce, forcing people who held gold to take a 40% haircut. Nixon did the same in 1972 when took the United States off the gold standard.

Government intervention has not always been so direct. Participants in the London gold pool participated in manipulating the price of gold in the decades prior to Nixon's taking the United States off the gold standard. The government has actively manipulated the price of gold ever since – see my many reviews of books on the subject here under Finance. Manipulating the price of gold and other precious metals had the objective of keeping the prices down, making the US dollar and other fiat currencies appear attractive.

The government intervenes in the stock market with the opposite objective, to make the American economy appear more successful than it is. This benefits the government in several ways. It makes the public feel better about the state of the economy, which is always a factor in elections. It artificially inflates pension fund holdings, raising confidence that money will be there to pay pensions. It boosts the value of the dollar, making it cheaper for consumers to buy imported goods.

Naïve perceptions need no manipulation

Casinos depend on the fact that most gamblers are not very good at figuring the odds. It is true that a few professional poker players, and some who play the horses, are talented enough to consistently make money. Casinos love these people because they give hope to the multitudes who consistently lose. Though they may intellectually understand that the odds are against them at the craps table, roulette, the slot machines, horse races, and of course the national lotteries, they bet in any case.

These same people play the stock market. At this moment they are rushing into Bitcoin as if there were no tomorrow. As I write the price of Bitcoin is at an all-time high of $72,000. It is up from $69,000 yesterday, $63,000 a week ago, $52,000 a month ago, and $16,000 just 14 months back. Most such investors do not know anything about public key cryptography, the history of Bitcoin, or the legal debate as to whether bitcoin is a currency or a commodity. They simply know that it is going up.

People like them are investing in Nvidia, making it the first trillion-dollar company on the stock market. Nvidia has all the right buzzwords – video gaming, artificial intelligence and so on. It claims a price-earnings ratio of 72. People have similarly invested in Amazon, Google, Facebook/Meta, Twitter, Amazon and other Internet companies. These companies' businesses and finances are hard to understand, and most investors don't bother. Only a minority of the investment flowing into these companies is from individual investors; most of it comes from fund managers. Both the individuals and paid managers are driven by a fear of missing out – FOMO.  The managers in particular are secure in the knowledge that they cannot be faulted for having gone with the crowd.

The upshot is that although astute professional investors have been claiming for a decade or more that the stock market is overvalued, it has continued to go up. People who can read financial statements, can accurately project revenue growth and so on, have bet against the stock market and have lost money.

This has happened many times throughout history. Sir Isaac Newton went broke investing in the South Sea Company. Many Dutch went broke investing in tulips.

Where does that leave us?

Two index funds serve as measures of market sentiment.  QQQ is a basket of the 50 or so leading technology companies on the NASDAQ. SQQQ is a leveraged fund that can be used to bet that the NASDAQ is going down. These graphs tell a dramatic story of the last five years.

QQQ is up over that five-year period from $174 to $439, a 2 ½ times return.  Enough to make anybody happy.

SQQQ has fallen from $1123 to $11 over that same five years. Anybody betting against the market over that period lost 99% of their initial investment. It was not a good time to be a pessimist.

But – that which cannot go on forever, does not go on forever. There are some straws in the wind. Bitcoin of course has gone wild.  The price of gold, which has been successfully suppressed for decades, actually crept up 58% over the period in which the NASDAQ was going up by 150%. It at least kept ahead of inflation. For such a stolid, traditional investment it has lately picked up some momentum – up 14% on the year, 8% in the last month.  My bet is that gold's momentum will continue to grow as conservative investors come to the conclusion that there is no more growth to be had in the overpriced stock market and that gold is the best of the safe haven alternatives.

I'm standing pat, content with my holdings in gold and precious metal ETF's. But I'm keeping my eyes on QQQ and SQQQ.  When the QQQ appears to be topish, I'll dip my toes in the water and go a little bit on the wild side.  Eddie and I will buy a little bit of SQQQ.  If nothing else, it will give us an opportunity to talk about how markets are made.

Celia Farber, whose AIDS book Serious Adverse Effects was sufficiently on target to cause Anthony Fauci to go out of his way to destroy her life, was one of the strongest and most effective voices in the Medical Freedom Movement occasioned by Covid 19. Saturday night she conducted a bold experiment, holding a Zoom meeting for her followers on Substack. It is an attempt to forge human connections out of the contacts that one makes over the Internet. She laments the fragmentation, the disorientation, the severing of connections that seems to have been an obvious objective of the whole Cоvid exercise and is looking for a way to bring us back together. A wonderful effort.

That's the news from Lake WeBeGone, where the temperatures dipped into the mid-20s for probably the last time until next November. Although the war news is not terribly positive, the Russians have not rocketed Kyiv for about three weeks now. We have gone from predictable, daily air raid alerts to every two or three days. Temperatures being headed for the 50s next week, we may get back to going to kindergarten and school by bicycle. I'm looking forward to it. After being under the weather most of the time November through January with viruses that while not serious kept me off my exercise bicycle, I am glad to be back in the saddle. Though 10% off my peak, I regain a little bit every day. It feels great.

Graham