Tuesday, January 16, 2018


[NOTE: Nothing in this article should be interpreted as
a recommendation to buy or sell any individual stock, or
to invest or disinvest in the stock market or any speculative

I have been “playing” the stock market since I was a young
teenager. I invested in common stocks and used techniques
such as puts and calls. At one point, and relatively briefly,
I was in commodities, I had an excellent technical economic
education in the time I attended the Wharton School of
Finance and Commerce. But please believe me, I am not an

I did learn a few things over the years. One was the value of
being a “contrarian” --- that is, the general technique of
doing the opposite of what most others are doing. It’s not
infallible, but it’s a very useful tool in investing --- and in
political commentary, as I have learned. In fact, it’s an
important insight into human behavior in general.

We are now in a very “bull” (upward) moment in many of
the major stock markets. Those who think a “bear”
(downward) market is imminent are issuing dire warnings
of either a major downward “correction” or an apocalyptic
market collapse. Whom are you to believe?

Let me go back to my very first class in finance at the
Wharton School many years ago. The professor opened
that first class with the statement:

“You will learn a lot at Wharton about the details of
economics, but I want you to remember this simple rule:
The price of a stock is the anticipation of future earnings,”

Since those days in the 1960s, public investing has become
very complicated with various new market techniques such
as derivatives, cryptocurrencies (e.g., bitcoin), new
commodities, etc. There were no computers, no cell or
“smart” phones, no cable TV programs. But my Wharton
professor’s simple rule still holds as a fundamental truth
in free market investing.

Over the years, I have also learned that stock markets
almost always over-react in the short term on both the
upside and the downside. I remember speaking with my
savvy stockbroker on the afternoon of Friday, November 22,
1963 after the market had been prematurely closed and had
taken an enormous tumble. “Buy on Monday morning,” he
told me. I was too shocked by Dallas, and too young, to do
anything, but sure enough the market quickly recovered on

On the other hand, stock markets in the intermediate term
(six to nine months) are often good predictors (barring
shocking events) of the general economy. The problem is,
of course, that we live in a time of frequent shocking events.

When Donald Trump stunned the nation’s pundits, and the
world, in November, 2016, the markets went briefly down.
But when the stock markets realized that President Trump
and the Republican Congress were likely to provide relief to
the economy and unemployment, the market recovered.

Until the tax bill was passed and became law, the market
hesitated. Once this legislation was in place, the market
has been soaring. The sum of investors now had concrete
evidence to believe that future earnings would go up.
Numerous companies promptly gave out bonuses to
employees. Corporate earnings held abroad (to avoid U.S.
tax penalties) began to return, There are expectations
that most U.S. employees will be soon receiving larger
paychecks. Unemployment continues to go down.

Does this mean the stock markets will continue to go up?

The markets now await new corporate quarterly earnings
reports. If those reports show increased earnings, barring
the unforeseen, bullish individual stocks will likely go up
(and stocks that do not show increased earnings will go
down). It’s a game of expectations. Corporate earnings
might go up, but if they are less than analysts and the
companies themselves predict, the stock might go down.
Earnings for the current quarter might be as good or even
better than expected, but these days, corporations also
make public predictions about future quarters (based on
sales or other projections), and if those are not what is
expected, a stock might actually go down despite the
short-term good news. Some industries or sectors also are
more or less favored by many investors, and multiples of
earnings per share can very widely for those stocks or
other investments which reap the attention of speculative
favor or disfavor. Some high-tech stocks have higher
earnings-per-share multiples because investors see higher
earning coming likely later, while some other stocks have
lower multiples because notable growth is not expected.

Peter Drucker, the wizard of management, wrote a book in
1976 called The Unseen Revolution in which he was among
the first to recognize the growing impact of pension funds
on the economy. He argued that the total investment of
workers’ pension funds in the stock market was so large
that it represented a kind of socialism, but he did not fully
take into account the distinction between stock ownership
and corporate control. Nor did he then know about the
immense  growth of personal IRA and 401-K funds that
would make up a major part of most individuals’ net worth.
Corporate pension funds have since declined. Government
and public sector worker pension funds, in many cases, have
became alarmingly underfunded. It is a very serious and
ongoing crisis. But the IRA and 401-K funds continue to be
the basis for most Americans' net worth.

The stock markets have not only an economic impact.
they have a political impact as well. Major advances in the
stock market create economic and political confidence
through increased individual net worth; major declines
disrupt that confidence.

There are many other critical factors is the movements of
markets. Supply and demand, inflation, emotions, stock
buy-backs, net asset value, impact of taxes and regulations
are among them. But the fundamental factor remains investor
anticipation of what the investment will earn.

For the moment, most investor sentiment is generally
positive. But, as we know from economic history, that can
change, and if investors think future earnings will go down,
the impact on the stock market could be dramatic.

Copyright (c) 2018 by Barry Casselman. All rights reserved.

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