Rising Markets Are Now a Public Good by, D.R. Barton, Jr.


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First, what is happening?

Well, we’re in the middle of some of the worst global crises in a long time…

The worst health crisis in a century and . . .
The worst economic crisis in twelve years, if not longer, because of that health crisis and . . .
The worst geopolitical tensions since the end of the Cold War three decades ago and . . .
The worst civil unrest in more than 50 years and . . .

. . . the Nasdaq is making new all-time highs.

Employment Numbers, Earnings, and Indexes

Last Thursday morning, weekly unemployment claims modestly exceeded estimates again with 1.877 million new claims. That kind of unemployment number was unheard of just months ago. How did the markets react? Up for the day. (I’ll avoid the debacle of wrong monthly non-farm payroll numbers on Friday – that’s grist for a whole other article. The systematic miscounting that plagued the Bureau of Labor Statistics during the Obama administration now plagues the Trump administration.)

Like most investors, you’ve probably long heard that stock prices are a reflection of companies’ future earnings. Clearly, however, that’s no longer the case. On balance, companies are going to miss earnings by far more than a few percent than they would have before all these crises hit and second-quarter earnings are going to be much, much lower.

But if you listen to the financial news media, to investment banks, or to government officials, they’ll repeat the old story about “future earnings” anyway. This is probably the biggest misconception in the markets right now. Owning stock is no longer about buying a share of a company’s future earnings. In that version of the market, investors win by making the best long-term predictions and traders win by predicting what investors will do next.

There’s a new truth now – the holders of power and information – news media, government (on BOTH sides of the aisle), and Wall Street have together turned stock markets into something else altogether.

Much like access to clean water and electricity, the power elite have turned rising markets into a public good. What does that mean? Let’s take a look.

401(k)s Were a Good Idea At The Start

It all started in 1978 when Congress passed that year’s Revenue Act. In it, a little-noticed clause called “Section 401(k)” gave workers a tax-free way to wait on cashing out their paychecks. Upper management was allowed to postpone cashing their bonuses or stock options.

When the law went into effect in 1980, a benefits consultant named Ted Benna at the Johnson Companies realized this clause could be used by companies to encourage their workers to save. Economists, human resources executives, and policy wonks all joined in to promote the idea of using Section 401(k) to help workers generate an add-on source of income in retirement through savings today. Up until that point, Social Security and defined benefit plans had been the main sources of retirement income.

A defined benefit plan also goes by the name of “pension” and it’s a simple idea. You work for a company for some amount of time and in return, the company promises it will pay you a set amount of money every year after you retire. These plans are called “defined benefit” because you know exactly how much money you’ll get out of them. They are easy to understand, provide a lot of security for workers, and pose little risk for retirees. The downsides? If you change jobs, you have to start over, working up to the number of years at which you become eligible for your pension. If your employer goes bankrupt, chances are your pension plan disappears with it.

On the other hand, a 401(k) plan is a “defined contribution” plan. You know how much money you can put in, your “contribution” but you don’t know how much your savings will be able to pay out in retirement. That all depends on what happens to the investments in the plan.

Defined contribution plans like the 401(k) were sold to the American public as having several advantages:

  • They are a way to save some extra money for our golden years. Economist Teresa Ghilarducci said in Congressional hearings that people would have to save as little as 3% of their annual paycheck to be able to retire nicely.
  • Your employer can also easily contribute a percentage of your savings to your plan.
  • You can take your 401(k) contributions with you when you switch jobs.
  • And probably the main advantage of these plans — you don’t pay income taxes on the money you put in. Instead, you pay income tax when you withdraw the money. Most people make less money once they retire so this aspect, on balance, would reduce your total income taxes paid over the same period of years.

In short, 401(k)s were a simple and flexible way of encouraging us to save a little bit more for our retirement.

That was the grand idea at least but . . .

401(k)s Haven’t Worked Out Exactly As Promised

Today, Ted Benna, “the Father of the 401(k)” and other early proponents of defined contribution plans now regret their earlier claims. 401(k)s have failed to deliver on their original promises.

Early boosters cite two main factors behind the failure. First, we are living longer than everyone expected. The money in those plans generates income for a period of time less than the average “full life” of retirees now. Second, market returns have been much less than we were told they should be. Ghilarducci (mentioned above) assumed that markets would go up 7% a year in and year out. After the crashes in 2001 and 2008, she now acknowledges her original projections were far too optimistic.

Those two market crashes have put many 401(k)s far behind where they “should” be or need to be – without accounting yet for the COVID collapse we just lived through. On their own, these market crashes might have been no big deal. After all, defined contribution plans were supposed to be just an add-on to Social Security and defined benefit plans. Originally, it was just a little extra to make retirement more comfortable . . . until the Big Four (Big Government, Wall Street, the news media, and Madison Avenue) realized the true full potential of defined contribution plans.

To get an idea of what I mean, take a look at this chart from the Wall Street Journal:

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As you can see, defined contribution plans (the blue line) have not supplemented pensions (the purple line) – they have replaced them.

In less than a decade, 401(k)s and similar defined contribution plans replaced pensions as the main source of retirement income . . . putting our retirement at the mercy of market investments. The reason for this switch is simple: for individual employers, a defined contribution plan is much cheaper and carries less risk than a defined benefit plan. On the other hand, a defined benefit plan is a promise to spend large amounts of money on every worker in the future. The financial obligation varies depending on how long retirees live. At the same time, the company can’t know how much money it will be making decades from now when those pensions obligations have to be paid.

Defined contribution plans are cheaper and less risky. Defined benefits plans are costly and involve more risk. In other words, the shift from pensions to 401(k)s was an inevitable cost-cutting move. At least, that’s the explanation you’ll hear from the power elites. Is it really so simple?

Now We All Need Stocks Always Going Up

As the chart from the Wall Street Journal shows, more than half of all households in America now have a retirement investment account. For many, that account will be their main source of income when they retire — if they can ever afford to retire that is. For many, retirement can only happen if markets keep rising — which suits those in power just fine. Let’s see why.

This suits the government which made it this way in the first place. After all, it was the government that allowed companies to replace defined benefit plans with defined contribution plans. It was the government that, in 2006, allowed companies to opt-in workers to 401(k) plans by default. Unless you look, you might not even know that a few percent of your paycheck has been going into a 401(k) plan at a new job — which should be a good thing.

This suits Wall Street just fine as well. The switch from defined benefit to defined contribution plan has been a gold rush for Wall Street heavyweights. According to the Employee Benefit Research Institute, Americans had a total of $5.28 trillion in 401(k) plans as of 2017. Or put another way, Wall Street has more than $5 trillion to play around with. Mind you, the all-in fee for a 401(k) plan is 2.22% annually on average. Do the math and you find that over $116 billion in fees goes to Wall Street firms every year. And 2.22% is just the average with some plans getting 5%. With so much skin in the game, with our retirements at stake, it’s no wonder Americans are so interested in what happens to the stock market — we can’t afford not to be.

This suits the media just fine. They get to write inane articles day in and day out that don’t tell you anything about how to actually make money on stocks. But the rank and file read them because they think they have to.

But it doesn’t end here.

Thanks to the Fed and other central banks around the world, interest rates have been zero or close to zero since 2008 . . . so the only investments worth putting in your 401(k) for years now have been stocks.

I’m sure Wall Street appreciates that.

All this means at least 63.5 million American households need stocks to keep going up. Much like clean water or electricity, rising stock markets have become essential to our retirement.

Of course, Wall Street also likes stocks to rise. Rising markets make it easy for them to make more and more money. And here, finally, we come back to why the government was so eager to put America’s retirement in the hands of the stock market all those years ago — only Big Government has enough clout to make sure stocks keep rising. We can see that right now with stock market levels flat or up for 2020 . . . despite a languishing economy. Almost one quarter of working-age Americans are out of a job right now and the Atlanta Fed predicts this quarter’s GDP will be down more than 40%. And then there’s the continuing COVID pandemic, tensions with China, and civil unrest.

The Market Miracle

What miracle is holding stocks at even levels or higher for the year? How about $3 trillion of Fed stimulus so far:

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The Fed’s assets include things that would have been unthinkable for it to hold a very short time ago: junk bonds, ETFs, and ownership in companies that would have gone under without a bailout.

Then there’s more than $2.2 trillion in stimulus Congress has passed so far most of which ended up in corporate hands. Somehow, all the “regular” people have received was a $1,200 check. With all that monetary and fiscal stimulus (more than $5 trillion total) — the stock market keeps rising even while the underlying economy has no prospects for substantial improvement for months … because now, the stock market is essential to our retirement.

A rising stock market has become almost a right, a public good. Like other public goods, life would be very difficult without it. Big Government is only too happy to help provide this new public good. In exchange for … Power, for your vote.

Yes, Big Government has done it because rising stock markets win elections. Since 1928, the incumbent party has won the U.S. presidential election almost every single time that the S&P 500 was in the green three months before the vote.

But don’t be fooled; ever-rising markets disconnected completely from economic reality are not for your benefit. The power elites will always have more skin in the game and will always profit more than you. Wall Street, Big Government, Madison Avenue, the news media – all use you, use your taxes, and now use your retirement savings to turn markets into an ever-rising source of money, power, and votes for them.

At least we finally know the game and a few of the rules.

Where Will the Money Flow Now?

Of course, I’m not saying there won’t be pullbacks in the market. There will be. The markets won’t literally always go up. In fact, February 18 saw the beginning of the fastest 30% pullback in the history of American markets. Then the fastest 30% rebound in history followed. We saw the Fed go all in to make this happen. After his first two announcements just sent markets down more, Fed Chairman Powell kept trying everything and the kitchen sink until something worked. Well, it worked for stocks at least. The real economy? Not much better just yet.

We may have more pullbacks over the summer, too. Any clear signs that we get a COVID spike from recent protests or a second big wave of infections in states reopening could send stocks down again. If something happens because of the worsening tensions with China, we could see a decline as well. For now, the tiff has been mostly harsh words without much in the way of tangible actions.

In the meantime, we have to accept markets for what they have turned into. Once we do, we can see how markets will keep rising at least for the intermediate term. It will be no surprise what stocks will lead the way because we have seen them rise for years now. The same few stocks push higher and higher as Wall Street buys them, the media hypes them, and Madison Avenue advertises them (insert anticlimactic drum roll here…) – the FANGMA clan. Facebook, Amazon, Netflix, Google/Alphabet, Microsoft, and Apple. All of them except Apple posted double-digit revenue growth in the last quarter. That’s right – they’re the largest companies in the world AND they keep growing by double digits.

Now that you know that the power elites have these symbols’ back, you know why I keep suggesting you buy them on every pullback.

Of the FANGMA family, my two favorites continue to be AMZN and MSFT. In addition to being the biggest online retailer and biggest cloud infrastructure service provider, Amazon will soon open a stand-alone delivery service to compete with UPS, FedEx – and yes – the USPS. Its upcoming foray into healthcare is one to the worst kept secrets on Wall Street.

MSFT has so many cash cows that it’s tough to get them all in one barn. In addition to the ubiquitous PC operating system and business software suite, it is the second biggest cloud player and has a big gaming platform rollout scheduled for the fall – just in time to capture more “remain at home” revenue.

These two companies have to be in your nest egg portfolio and adding more when they have pullbacks is not a bad idea, either.

This is a fairly broad assessment but if the 2009-2020 bull market taught us anything, it’s that massive stimulus eclipses everything.

I’d love to hear your thoughts and feedback – just send an email to drbarton “at” vantharp.com.

Great trading, stay safe out there and God bless you,

D. R.


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