MUPPETS

6 ‘facts’ that stock-market bulls are wrong about

By Brett Arends, MarketWatch

At the start of the soccer World Cup a month ago, everyone knew, they just “knew,” that Brazil was going to walk away with the tournament.

Brazil hadn’t lost a major game at home in decades, said the experts.

The Brazilians had the best attack, the best defense, the best team — the best everything, they said.

And these weren’t just opinions. These were analyses. Quantitative Analysts had produced algorithms — indeed, Proprietary Algorithms — using vast quantities of data to prove their point.

And if you can’t trust a Proprietary Algorithm, what can you trust?

Really, what else was there to do but to prostrate ourselves in awe before the quants and begin chanting in worship once again “Algo akbur! Algo akbur!” – “The Algorithm is Great! The Algorithm is Great!”

Oh well.

So much for the conventional wisdom. So much for the quantitative experts and their spreadsheets.

Brazil’s humiliating exit in last week’s semifinal 7-1 rout was among the most extraordinary events in World Cup history. No one — least of all me — predicted any such thing.

But Brazil nearly exited the cup much earlier. The Brazilians came within inches of being defeated by Chile in the second round, and might, indeed, have lost to Colombia as well in the quarterfinals.

The soccer World Cup is over. But the money World Cup — also known as financial markets — continues, as ever.

And while we’re on the subject, here are 7-1 (or “6”) other things that everyone “knows” to be true. which actually aren’t.

1. ‘On average stocks earn 10% a year.’

Actually, depending on the Wall Street marketing department you’re listening to, this may be downgraded to 9% or upgraded to 12%. Regardless, it’s total balderdash.

The 12% figure is derived from a meaningless piece of statistical chicanery called the “arithmetic mean.” It can be dismissed.

Since the 1920s the compound return has been around 9%, but this, too, is grossly dishonest. These numbers include phony profits caused by inflation, and one-off gains from an upward revaluation of stocks which, by definition, cannot be repeated.

Bottom line? The best, most honest guess is that stocks are likely to earn you, after inflation, the net dividend yield plus roughly 1% to 2%. There’s some dispute about the net dividend yield because of the question of stock buybacks, but overall we’re looking at real returns of maybe 4% a year, if we are lucky.

2. ‘There’s a lot of money on the sidelines waiting to come in to stocks.’

You’ll hear this repeated over and over and over again by stock market scalpers.

But there is absolutely no money on the sidelines waiting to come in to stocks. None. Zip. Nada. Rien. How do we know? Easy. Every time somebody buys a stock, somebody else has to sell it.

Think about it.

You’ve got $100 “on the sidelines” and you want to “put it to work” (yeah) in stocks. So you use it to buy $100 worth of stocks from, say, me. What happens? Before the deal you’ve got $100 “on the sidelines” and I’ve got $100 worth of stocks. Afterward you’ve got my stocks, and I’ve got your $100 in cash. Back on the sidelines.

3. ‘Economic growth will be good for stocks.’

While the economy was flat on its back, the hucksters told you that this would keep interest rates low, and that was good for stocks.

Now that the economy seems to be recovering they’ll tell you this is great for stocks, too.

The real problem? There is no link between economic growth and the returns from the stock market. No, really.

From 1968 to 1982 the U.S. economy grew by 50% even after adjusting for inflation. Yet over that period investors actually lost money in real terms (even before you count taxes and fees).

The Japanese economy is a third bigger than it was in 1989, but anyone who invested in the Nikkei 225 index (TYO:JP:NIK) back then has lost their shirt.

Economic research has shown that, if anything, the fastest-growing economies have tended to produce lower, not higher, stock market returns.

The U.S. stock market has boomed in the past few years, in large part because the aggressive actions of the Federal Reserve have driven down the short-term costs of borrowing. If the economy picks up the cost of borrowing will rise. Do the math.

4. ‘You can’t beat the index.’

It has become a new mantra, almost a new religion: Financial experts will tell you that the market is so “efficient” at setting prices that you cannot outperform the index—such as the S&P 500 index (SNC:SPX) –without taking on more risk.

Trouble is, this is wrong.

There is a lot of research showing that over time you could have beaten the index simply by investing solely in “value” stocks, namely those which were inexpensive in relation to fundamental measures such as net assets or dividends. You could also have beaten the market by investing in stocks of “high quality” companies, or in stocks with lower volatility, than if you had invested in the standard index.

What people forget: The standard indexes are very peculiar. They are heavily biased toward the most popular stocks, as those have the highest market values. So when you invest in an index fund, a large chunk of your money goes into a few names. Just picking stocks at random, and investing in them equally, has produced better returns than the index.

5. ‘U.S. corporate balance sheets are in great shape.’

Really? Perhaps this explains why, according to the Federal Reserve, U.S. (nonfinancial) corporations today owe a record $9.6 trillion — twice as much as at the start of the millennium, and a rise of 27%, or $2.1 trillion, in the last five years. Indeed, so far this year U.S. nonfinancial businesses have been borrowing nearly $10 billion a day, including Sundays.

Naturally, assets can go up as well as liabilities. Some companies, indeed, are holding large piles of net cash — mainly overseas, to avoid the taxman. But overall, according to the Federal Reserve, nonfinancial corporations now carry credit market debts equal to about 50% of their net worth, near record levels.

The equivalent figure in the early 1950s? About 21%.

6. ‘U.S. households have rebuilt their balance sheets since the financial crisis.’

Sure, why not? Actually, since the start of 2008 households, overall, have slashed their total debts by. er. about 6%. Wow.

Oh, and the bulk of that reduction hasn’t come from people paying off debts, but from just writing them off. Much of this modest overall debt reduction has come from mortgage defaults, “soft” defaults such as housing short sales, credit card defaults and personal bankruptcies.

And despite that, overall household debts have actually been going up for the past two years. As fast as some people have been walking away from debts, others (or perhaps the same ones) have been borrowing more. Ten years ago, in the bad old spendthrift days before the crisis, U.S. families owed $10.5 trillion. Today? Er. $13.2 trillion.

As soccer fans have just been reminded, just because everybody “knows” something doesn’t mean it’s so.