When I was a Finance major in my college years, it was exciting for me to learn how the stock and bond markets were the very basic tools by which our capitalist economy functioned. Capital produced by these markets provided the funds to create the goods and services purchased by consumers. In the first two decades or so after World War II, the markets were very orderly. Interest rates were the price of credit, loans seemed to be made conservatively and rates remained stable. AT&T and IBM stock prices increased 10% each year based on the fact that the business revenues and profits increased at that rate and stock prices were stable. New companies appeared at reasonable capitalizations. Business declined at other companies and their stock prices reflected the change. New medical products were promised at new medical companies but never materialized and those companies went out of business. But about thirty years ago, the stock market and the bond markets began to experience wild gyrations in valuations. What changed to make these very important markets to our fragile economy so volatile?
In order to better understand why these changes occurred, we must understand the backdrop. The Federal Reserve Banks lowered interest rates to substantially lower than required by economic conditions and also started purchases of outstanding bonds. This flooded the market with additional capital at low cost and inspired major investors to invest in many new ideas. Corporations borrowed money here at lower cost, but invested it all overseas because manufacturing had all been transferred to foreign countries by trade agreements made during the Clinton Administration. Government borrowed vast amounts of money increasing debt to historic levels. Both the administrations and the Federal Reserve during the past thirty years have created vast amounts of capital for the markets, none of which was required to produce goods here in America since that was all being done in foreign countries. This is enormous negative interference by the government in the local economy, but that is a different subject.
These changes made to our economy by government had enormous impacts on the markets. Corporations overborrowed and underused it in our economy with the effect of creating possible shortages of supply locally. Potential inflation is created and the potential of negative effects of rolling over debt when interest rates rise is also created. The stock market was broken down into several very different parts. Unlimited capital availability made it possible to create tech giants like Facebook and Google which are essentially games and information providers. They produce no potatoes or tomatoes, washing machines, TVs or cars used by consumers every day, but they and other companies like them became the major focus of investment capitalists. Major investments were made in cryptocurrencies also which produce nothing we need. We are now in the process of also creating a metaverse which will also be nothing more than a purchased entry on someone’s computer and provide no goods produced for our economy. These and other corporations engaged in manufacturing or other activities became international in scope and increased in size exponentially. Other companies are domestic in scope and therefore a different stock category. Many new companies, some of which are considered to be disrupters, were also created because of capital availability but are mostly smaller in size. Changes in government policy have also taken place. There has been increased focus on environmental changes which is causing a complete change in direction in certain industries. What has been the impact of this vast government interference in our economy?
To begin with, we must understand that there is practically no retail investing anymore for many years. Investment managers that manage huge investment funds make nearly 90% of all the trades that take place every day. These investment managers all seemingly went to the same school and use the same rules. The result is that whatever they decide is best becomes a self fulfilling prophecy. The have decided that they will not fight the Fed. So, when interest rates are down and money is available and cheap, they buy stocks up to the sky. When the Fed raises rates as it is doing now, they sell everything into the sub basement. They also select the stocks that they believe will be the best gainers, and all of their portfolios contain the same basic companies. The result is sky high prices when markets are up and huge losses on stocks when markets are down. They have also learned certain algorithms or mathematical formulas that they use to automatically effect trades if certain events occur. This adds to volatility. Investment managers have decided that small growing companies which need capital will struggle when rates are high to obtain the capital they need, so they sell them all. The obvious result is way underpriced growing companies. It seems that everything these people have learned about how to invest our money in the stock market results in a complete loss of the capability to price stocks according to the approximate value of the company they represent. If you buy stocks according to fair value as I always have, you will not maximize profits when stocks go up and you will buy stocks priced priced at low value that get decimated when markets go lower. When the government decides to crush the business of the oil companies because they want to promote environmental issues, investment managers will run and hide in oil company stocks whose business is declining but their profits are rising. Solar industry stocks losing money and supported by government will double in value in a falling market. Investment managers will hide in cash and non growing companies denying capital to those that need it when markets are going down. The stock market is no longer helping the economy remain sound and growing and providing it’s basic purpose. Bond markets have been devastated due to poor lending practices during the Great Recession and been decimated by unnecessarily high rates orchestrated by the Federal Reserve Bank.
What do we need to see happen in order for our economy and the resulting markets to return to normalcy? We need to see manufacturing of products used in America manufactured here in America. Reliable supply helps reduce inflation and provides good paying jobs that contribute to growth in our economy and adds to America’s security. Wasteful government borrowing and spending must stop. It contributes to inflation. America is well over $30 trillion in debt equal to nearly $300,000 per household in America. Inflation, government debt and resulting recession caused by Fed reaction to inflation has a dramatic effect on the markets. The Federal Reserve Bank controls the stock market today because investment firms will not “fight the fed”. And the bond markets and consumers and local manufacturers are all affected by recession caused by the rate increases. We need to return to an investment ideology whereby investment firms learn better to evaluate stocks based on company fundamentals. Even the ones who try to do this today use poor formulas. It stands to reason that different industries should be evaluated on different bases. Some require heavy capitalization, others do not. Food retailers have very low profit margins. Some industries are more competitive than others. We must limit the availability of capital used to create games or entries on someone’s computer which create no products or services we need because this limits capital availability for more useful investment and would therefore be inflationary. Most importantly, we need to reeducate our investment counselors who do not seem to understand how to put our investment funds to good use for the benefit of the economy as well as for our own safety of investment.