Who Wins in the Stock Market?

Alessandro Bruno

Stocks Are reaching Record Highs Amid a Collective Delusion. But, Who wins, and who loses? Caveat Emptor

There are periods of collective delusion. As the Dow Jones seems ready to hit a new record of 29,000, it’s worth asking whether the real economy supports that kind of performance. History doesn’t repeat, but it’s worth noting that the years of Wall Street’s uninhibited growth that preceded the great crashes of 1929 or 2000, 2007-2008. They share a common ingredient with the present period: irrational exuberance to quote former Fed Chair Alan Greenspan. During such phases, share prices appear to rise as if the market were one massive tide. The sensation, then, takes arises that investors don’t need particular strategies. You can earn by buying stocks at random, picking them according to where darts land on the board at the local pub, and then selling them whenever you feel like it. At that point, you may start asking whether there are strategies that allow us to do better than the market average, forgetting – or even denying – the very possibility that markets go down, as well as up.

It’s when the markets go a little flat that questions start to emerge. If the Dow Jones Industrial Average index (DJIA) gains and loses within a narrow band – the markets are flat -whenever you win, someone else must necessarily fail. It’s not unlike balancing a chemical equation. It’s such a market that demonstrates the fact that there are no infallible strategies that deliver gain without pain in the stock market. After all, should such a plan exist, and be available to the public, everyone would use it. There would be constant growth. Perhaps, the more conspiracy-minded might like to believe that someone, an international man of financial mystery, does hold the secret. Yet, the more sensible among you will correctly come to terms with the fact that such a strategy simply does not exist. Without a plan for systematic gains, there can be no strategy to prevent loss. There are no insurance policies on the trading floor.

On Wall Street, the best system is Caveat Emptor: buyer beware.

Of course, some of the people are right some of the time. And there are ways of looking are markets and risks that offer more insights than others. One of the best, and the focus of this book, is geopolitics. Far from certain, as the end of the Cold War inspired many academics to believe, the world has been heading ever more toward a new anarchic world order. The United States will no longer be the world’s sole economic and military superpower by 2050. A new power is emerging; it’s China. And the shift will be as inevitable as history itself – so will the resistance to the change.

Note, geopolitics can be as ineffective as any other method in predicting – with pinpoint precision – a financial crisis, a recession, or a stock market crash. Nevertheless, given the protracted timelines of geopolitical and related (military) developments, the analysis of global political risk, the international zeitgeist, particularly from the perspective of superpower relations, can help investors identify long-term opportunities in the stock market and, inevitably, gold. The key is to do the homework rather than blindly trust mainstream media reports.

The Ponzi Scheme Syndrome

The alternative, that is taking the risky route, may lead to a rather unfortunate realization: equities behave much like a Ponzi Scheme, which means a stock market crash is always lurking.

There’s something straightforward, essential even, that few finance insiders ever share with the “normal” people. The concept of the stock market as a Ponzi scheme is not new. After all, even a Ponzi scheme makes money for some of its investors. For instance, when Bernie Madoff was arrested, the books showed that over half his clients were, in fact, making money.

A Ponzi scheme makes money for the initial “investors.” They join or “invest” in a company or entity, and they are promised a substantial return on investment. But, this money comes from other such investors. The latter must, in effect, lose for the others to win.

The very value of the stock market, or at least what is presented as its value, should raise eyebrows.

The Russell Index, which represents about 99% of the total capitalization of the U.S. stock market, is worth some $31.0 trillion. Yet, what’s even more astonishing is that as of December 15, 2019, the total amount of U.S. dollars in circulation was $1.79 trillion. In other words, the full value of the stock market is over 18 times the value of all stocks traded on Wall Street.

If all investors decided to cash out of their stocks tomorrow, there would not be enough money to pay them. And this brings us to the first rarely observed aspect of stocks: They represent an ethereal value.

They are not “worth” actual money, and shareholders should avoid speaking of their net worth in terms of stock holdings. At $30.0 trillion, investors might otherwise feel as if they deserved $30.0 trillion in hard cash. The kind of money that the U.S. government guarantees as legal tender. Businesses have a legal obligation to accept U.S. dollars in exchange for the goods and services they provide.

Wall Street and Las Vegas Have Much in Common

They are not obliged to accept stocks. Perhaps it’s one reason why even investors who have used their savings to acquire equities, deep down fear the inevitable parallels the latter have with gambling. Gold remains the one pure form of investing or safekeeping of assets. But the fact that the yellow metal has dropped below its recent $1,300-per-ounce price suggests that investors have not pondered the risks they have taken by investing in stocks.

In effect, these risks have much more in common with those that Bernie Madoff’s clients absorbed when they wrote checks to the now-convicted swindler. Indeed, unlike gold, whose value is mainly determined by its rarity, history, as well as a factor of supply and demand, stock valuations are a murky affair.

It is sometimes better to be a clinical psychologist or a writer able to capture the zeitgeist to predict financial scenarios and a stock market crash than an analyst on Wall Street.

Analysts, who look at charts and numbers, are ill-equipped to understand what’s driving bearish or bullish sentiment. And that’s because speculation is not a quantifiable entity.

What Is Speculation?

The word derives directly from the Latin “specere,” which means to “see deeply” or “see far.” Look-out guards in Roman times were responsible for the activity of “looking far.”

In the more philosophical sense, speculation has, therefore, acquired the meaning of “look far beyond.” More simply, it carries the spirit of predicting the future.

In the financial context, speculation is an activity, or impulse, to approach the market and invest liquid funds in stocks or related instrument. The key, of course, is that the investor chooses the stock, option, or derivative, making high-risk assumptions about developments, positive or negative (long or short) that will occur in the near or distant future.

The outcome of those assumptions will depend on whether the developments, which the investor expected when he or she decided to enter the market, occur. But, given that events occur randomly, there are no assurances. Thus, there is always the chance the investor may suffer a negative outcome based on expectations.

As the great economist, John Maynard Keynes said, it’s not enough for a single investor to “see the future.” Others, many of whom unfamiliar to him/her, will have to share that same vision for the desired outcome to occur. Keynes suggested that speculation was an art. It aimed to guess what other market participants expected in the future. To pick a winning stock involves understanding how the other investors will act.

That’s why charts work sometimes. But charts always reflect past thinking or expectations.

That’s why, every day, there is a chance of a stock market crash. Not everyone will see the same thing at the same time, all the time. But, the kind of Dow Jones records set in 2018 saw many stocks—benefiting from a collective “speculation” related to the Trump tax cuts.

Now, it’s anyone’s guess how long that speculative effect will last. It’s a mental game as to who can stay optimistic the longest.

Betting long on stocks because of lower tax rates—which were supposedly going to help everyone instead of allowing the rich becoming richer—was the textbook definition of speculation. Indeed, the bullish market was the outcome of an expectation without any solid statistical basis.

In fact, the last such effort to induce a transfer of wealth from rich to poor through tax cuts for the rich—during the Reagan era—failed. Therefore,  statistical information should have encouraged a more bearish expectation. Regardless, investors on Wall Street have officially become exposed to significant risks.

The speculative drive that pushed the Dow to touch 28,000 points can quickly reverse.

After you’ve gotten your head around the concept of speculation and predicting collective behavior, there’s still a fundamental question few remember to ask.

After a stock market crash or a correction, where does the “lost” value go?

The Dow has dropped about 2,000 points on several occasions. Where did the lost points—representing billions of dollars—end up going? As individual investors, whose stocks fell, worry about what to do in the financial equivalent of Hamlet’s dilemma, consider that the stock market’s loss has gone nowhere. All the stocks’ values, until cashed and liquidated, have no cost, as such. Thus, the stock market technically lost nothing because stock valuations were not really based on hard cash.

And that brings us back to the problem of the stock market running on fumes. People invest because there’s the suggestion of payment. Stocks go up, and they come down. But they are based on thin air or a house of cards.

The stock market represents, at best, the promise of payment. Investors must believe that other investors keep guessing and speculating. If one too many an investor decides to cash in and pull out, it could spark a financial avalanche.

Alessandro Bruno

Alessandro Bruno

Alessandro Bruno, born in Naples, (BA and MA in International Relations, University of Toronto). Alessandro is a research analyst and writer in various business sectors and international politics. He was a Programme Officer for the UN in North Africa and a senior for one of the first international sustainable investment...
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