Thinking About Investment
From Zanecorpwiki
Contents |
Axiom: All Things Are Invested
In the broadest (non-technical) sense, an investment is what we do with resources. Time, money, materials must at every point be used in some way. This includes "non-use". Watching TV is just as much an investment of time as reading a book or putting in overtime. A box of nails sitting in your garage is invested in non-use, which is often a positive hedge against future need.
In this sense, all things are at all times "invested". The only question is where and how?
Axiom: Investments Yield Returns
All investments yield returns. Returns can be measured against many metrics. For any given metric, an investment may have no significant effect, and thus have a yield of zero. Furthermore, each actor's universe of metrics are operationally defined such that positive returns correlate to positive utility.
Theory: Aggregate Performance
The sum of all individuals yields for any given metric is identical to the aggregate yield over the same universe of consideration.
Conclusion: Our Expectations are Unrealistic
While doing research on real estate returns, I came across a thread that went something like this:
- "Is real estate investment a good idea?"
- "No, you should just buy stocks."
- "But real estate is working out for me."
- "Stocks have a 10-12% return."
- goto 3
The basic idea of the stock boosters was that you're a fool to invest in anything but "the stock market"[notes 1] because the returns are high and virtually guaranteed. If we grant that this is more or less a true historical analysis, we are still left with the problem that we're not investing in stocks in the past, but in the present, and our present investment depends on future performance.
Should we expect a 10-12% return on today's stock investment? The past is often a good indication of the future, and we must accept a high bar to overcome when we say "tomorrow will not be like today." If we accept our axioms, however, the proof is rather simple.
The growth of the US "economy" has held steady at between 2-4% since 1943.[1]. Assuming that the "stock market return" and "GDP growth" are using tightly correlated metric with 1-1 mapping, then for the facts of 2-4% GDP growth and 10-12% stock market growth to be true, then one of the following conditions must also be true:
Alternative One
To the extent that GDP is a measure of the real economy, the stock market must be either inclusive of or largely orthogonal to the real economy. The idea that the stock market is inclusive of the real economy may not be crazy, but on the other hand, I don't see how it could possibly be true. The implication, as far as I could see, would be that stock market growth is somehow a super set of GDP growth, roughly meaning the stock market is a better measure of "the real economy" than GDP, GDP accounts for 2-4% of that growth, and that something else other than GDP accounts for the 8% difference. This would imply that "something" which no one I know of has ever described is accounting for 2/3'rds of economic growth.
The other possibility would be that GDP and the stock market are largely orthogonal and the "real (money) economy" is more or less "GDP + the stock market (+ potential other stuff)". As far as I can see, this might be a true in the sense that such a model might be non-contradictory and useful. However, we would still need to explain the disconnect.
Alternative Two
The stock market is tightly correlated with GDP, but enjoys a consistent amplification. In other words, the world is essentially unfair. If you're born with enough money to buy lots of stock and you can afford to let it sit a long time, you're set. By doing nothing but signing up for a brokerage account and buying an index tracking fund, you will become far, far richer than the average individual and double your relative wealth every 7-10 years. By the time your 40, you'll be 30-40 times richer relative to where you started.
If, however, most of your money has to go towards water, food, shelter, and the necessities of life, then you are screwed. It's possible you can work hard, get really lucky, and strike it rich in some other way, but odds are that despite your intelligence, will, or good looks, you'll always be relatively behind every single person who was born with extra cash and wasn't so stupid as to simply not take advantage of the incredible relative advantage of stocks.
To be clear: the only way to get relatively wealthy on hard work, brains, or dump luck is to average an annual relative productive output 300-500% higher than the baseline average. In this alternative, that's the advantage the guy who inherited some extra money has, and that's the bar for relative wealth.
Alternative Three
The stock market is not tightly correlated with GDP. In other words, the sock market is bullshit. At least that's the most direct I can see of putting it.
Conclusion
The common conception of how things both should and ought to work is that the stock market should and is in some real sense a subset of GDP. Yet if this is true, and the stock market roughly represents a class of monetary investments while GDP roughly represents the output of monetary investments "in real terms", then we have a real problem because the stock market is clearly such a better monetary investment than everything else generally available on the market. Why would anyone ever give more than a small amount of cash to the bank, or ever invest in real estate, or make loans, or do anything but invest in the stock market?
The answer is they wouldn't. It is thus necessarily true that the stock market is not real, access and outcomes within the market are artificially controlled to benefit some and harm others, or some combination of the two. In other words, the stock market necessarily violates free market principles.
In a free market, an investment with relatively lower risk and higher rewards than everything else available should quickly be corrected. Instead, the difference in the performance gap has gone up, not down. (TODO: back up with historical data, stock market returns from 1940-50 over GDP in same period, versus 1990-2000. Do for each decade. I'm pretty sure, but if I'm wrong about this, then maybe it is correcting, just not very fast. This would be a plausible, though much weaker argument.)
If we do not see this correction, we must conclude that the stock market--through either internal or external regulation--is not a free market. Individuals are--judged by the free market compass--unfairly excluded and participants are unfairly rewarded.
I postulate that what we see with the stock market is a combination of limited access (simple unfairness) and a fairy tale. The unfairness has already more or less been proved in the discussion of the second alternative. The scenario laid out therein is indicative.
However, while we see the rich get richer, we don't see it at quite the rate predicted by that scenario. I believe this is because the third alternative is true. I.e., the stock market is to some extent real, in that investments in the stock market are correlated to effects in the real economy, but highly unfair in that the stock market returns are magnified beyond those of the real economy which is supposed to underlie it. Access to these magnified returns are artificially restricted.
Before you accuse me of agitating for complete financial deregulation, let's consider the second part. Much of the action of the stock market, however, is disconnected from the real economy. The transaction costs inherent in the conversion from cash to stock are actually quite high. Actual fees and such are relatively low, but the information necessary to effect the conversion regularly and with predictability is unevenly distributed. Some actors have special access while others just get lucky and happen to be in the right place at the right time. We extol these gains as "success" when the gains are in fact down to cheating or dumb luck.
Since lightning doesn't strike twice, the simplest answer would be that long term, institutional success is down to cheating. Much of the action of this cheat is performed by gatekeepers who manipulate when and where conversion happens such that paper wealth can go up and up, but when it comes times to cash in the chips, certain people always end up at the front of the line. Enough "others" are let in to avoid being too obvious, but the majority are always and must always be left out in the cold.
In other words, by simply looking at the scale of returns that happen "in the good years" versus the real economic growth, we must conclude that boom and busts cycles are the mechanism by which "insiders" consistently beat the market. Even if not individually so, the culture itself is knowingly and cynically manipulating perceptions to make unjustified and inefficient gains in the real economy.
Starting with a baseline in 1940, the tendency of stock market returns to increase through to the current time while GDP growth has decrease is evidence for this position and causes serious problems for those claiming "the stock market" (and I suspect many other financial markets) is a legitimate market.
Propositions
Proposition: The Metrics Underlying Stock Market Growth and GDP Growth are Tightly Correlated with a 1-1 Mapping
References
Notes
- ↑ Which for our purposes we can equate to an index fund, which seems to be the general implication.
