John Kay writes about an old Rothschild legend that illustrates an important insight: we put people in jail if they get an advantage in the market by talking to insiders, but we let them spend hundreds of millions of dollars tunneling cables through mountains so they can trade a few milliseconds faster. In both cases someone profits from knowing the news before anyone else. So what’s the difference?
He ends the article by asking “Why should it be unacceptable to gain advantage from knowledge of the outcome of the battle but acceptable to gain advantage by getting faster to London with that news?” I think he knows as well as us that there is a difference. We punish insiders because the incentives of fully legalized insider trading would harm the markets a lot more than anything that’s legal now. Even if the enforcement goes too far that can still be a good thing since it deters market manipulation.
On the other side, insider trading that doesn’t involve market manipulation could be a good thing. If someone knows of bad news that is about to come out and starts selling large quantities of a company’s stock, that will drive the price down earlier. This saves uninformed buyers from over-paying for a stock that is about to crash. In this case the insider makes a profit but also performs a public service. That’s just the invisible hand of the market – the same standard we expect from any corporation.
This probably can’t be separated from the less beneficial form of insider trading. Similarly, high-frequency trading might get the news out sooner but it can also be used to simply run slower traders in circles, and it should probably be taxed to lessen the advantage. There is a public benefit from committed long-term investors working with transparent prices in a market where they bear full responsibility for their mistakes. Anything else should be watched very closely.
A few months ago I wrote about why I thought Apple’s stock was over-hyped – it has good profit margins now, but it will be nearly impossible to hold them up as competition increases from other manufacturers such as Samsung.
Now Google is openly going after the iPhone’s profit margins. They aren’t doing this to take the profit themselves, but rather to lower the cost of smartphones. A Google executive at Motorola states “Those products earn 50 per cent margins. We don’t necessarily have those constraints. Those [margins] will not persist” as they prepare to launch a new phone that will be “priced well below the iPhone 5”.
As the article mentions, smartphone prices haven’t really declined over the last few years in the same way that other electronics tend to do. As new technologies spread amongst manufacturers, it seems like it will only become more difficult to create a product unique enough to command sustainable high profit margins. And if someone does, there’s no telling which manufacturer will get there first and push everyone else out of the market for a few years.
But there’s always the watch market right? Haha, just joking. When I think of watches I remember brightly-colored plastic and $15 price tags. If Apple is shameless enough to jump into that market, look out below!
The long line of excuses for poor service continues with this Investment Executive article, which details all the good reasons that advisors should not be held to a fiduciary standard of duty (in other words, legally bound to do what they keep promising).
The article goes into all the liability that they would face if they made a bad recommendation that caused a client to lose money. For example it says that advisors couldn’t protect themselves by saying the client understood the risks, because “CSA’s consultation paper indicates that the vast majority of clients are assumed to have little financial knowledge, and therefore can’t be expected to comprehend the risks – even if they were appropriately disclosed and explained”.
The article goes so far as to make it sound like advisors would be sued by every client just because they could have made a slightly better decision if they knew the future, saying “The client bears absolutely no responsibility for his or her poor choices, even though the client is the ultimate decision maker”.
However, I wonder if this opens up a big hole in the concept. A lot of clients probably don’t follow their advisor’s recommendations. So if the advisor recommends one thing and the client tells them to do another, is the advisor still liable? If not, that could leave a lot of clients still vulnerable to bad investment decisions. In fact there might be room for sneaky advisors to softly say the “right thing to do” while also hinting that there is a much better investment (that also generates more fees) to entice clients to override the advisor’s recommendation.
On the other side if the advisor is still liable for following the client’s instructions, then a lot of clients would probably end up being upset that their advisor won’t do what they want and will even leave the advisor.
There don’t seem to be any easy answers for this, but I would imagine that full disclosure of the fees that clients are paying would also help avoid many hidden dangers. That way clients could at least see that certain investments pay the advisor a much higher fee, without having to dig in to a 90-page report. They might still choose to believe that it costs more because it’s better, but I think a lot of people would be more cautious if they knew that their choices resulted in thousands of dollars in additional income for their advisor. In the end I’m glad that I don’t need to trust someone else to make decisions for me.
After the quick rise that I noticed last week, the US stock market index has kept going to reach another milestone. As we know the recent low was $666 during the day of March 6th 2009 (if you search for that now you will find some seriously weird websites – including one blogger who takes credit for calling the bottom a full month after it happened). As I watched the Google Finance page this afternoon it rose to $1,666, marking a gain of a full 1000 points in 4 years, 2 months, and 11 days. It actually went up to $1,667 for a few minutes before traders wised up and brought it down to close at a more significant number.
It’s interesting to note that if you read anything about investment back in early 2009, all you saw was warnings about how the stock markets were sure to crash again soon and you had to get out before that happened. And that is much the same as what you will read today. Obviously the price was a lot better in those days. But we still seem to be lacking the blind over-enthusiasm that marks a bubble. We’ll all be better off if it doesn’t come back.
For a while I’ve been wondering what it would take for investors to pile back into stocks. A lot of investors left the market in the last 5 years and haven’t returned, but eventually rising prices should be enough to convince them that it’s safe again. Of course by the time they jump in again it won’t be safe and they’ll have missed out on the best gains. Still, the recent price rises in the US market seem to only be fuelling fears that keep people away from stocks.
But I think I’ve finally found what it will really take. While I was reading an article on the Globe and Mail, a sidebar linked to a video titled “With Falling Gold Prices, Investors Turn To Stocks”. So it turns out I was missing part of the story. People weren’t content to merely sell low and buy high in stocks, sitting in unproductive cash or bonds while waiting. They had to go out and lose more money speculating on gold first. I guess that leaves them with less to move back into stocks now.
One of the nice things about switching our portfolio to ETFs is that I can do my weekly update on Friday at 2PM when the market closes instead of having to wait until the next day to get the latest e-Series unit values. While doing that I noticed that the S&P 500 closed at $1,633 today, and it was at $1,537 on the week of April 19th. That means it has gone up by nearly $100 over those 3 weeks.
Although the market can be quiet most of the time and dangerous at other times, things like this also happen regularly. A lot of the long-term returns seem to come over a few short periods. Those who try to time the market can easily miss out on moves like this.
A lot of people are talking about the dangers of investing in the stock market now that it has risen so much in recent years. There are a few flaws in these arguments but one of the interesting things is that the true reason behind them is the same one that drove investors to be very aggressive in 1999 and 2006.
If you go back 10 – 15 years, many investors had seen a very long and seemingly unstoppable bull market for stocks starting in the early 80s. There were a few crashes, but what they learned was that these were great buying opportunities because the market always came back fast and reached new highs. They had completely forgotten the multi-decade bear markets earlier in the last century. As a result, if the market was going up they thought it would go up further and if it was going down they thought it would turn around soon.
This rush of confidence led to a peak in 2000 and again in 2007. Finally the news 5 years ago was enough to break investor confidence and they really sent the markets down. But now we’re seeing the same logic play out with a different reference point.
Many investors can look back and see that the stock market hasn’t increased by much since 2000. Many indexes have barely passed their levels at that time. If you account for inflation the picture looks even worse; the peak S&P 500 value 13 years ago would be around $2000 today. So investors have learned that stock markets don’t really go up and if they do they will probably crash again soon. We are forgetting the times when the market has done well.
Despite the large gains we’ve already seen this year, this seems to still be the dominant mindset among investors. In 1999 it was easy to think that the stock market goes up a lot, and hard to believe that it should come down at such an exciting time. Now it’s easy to think that the stock market never really advances in such a dangerous time.
We need to remember that since it tends to have an increasing value over time, there is nothing particularly dangerous about reaching new highs. This should happen regularly. And prices that were once normal eventually become so low that we will never see them again.
It’s entirely possible for the market to set a record high and then never fall below that level again. It’s possible for the market to rise a lot, and then rise some more. The rate of return may decline for a bit after a large jump, but if the fundamentals have gotten ahead of the prices then it’s still a safe market. The highest price we’ve ever seen might also be the start of a bull market.
For example in early 1985 the S&P 500 reached a price of $177. It had never been that high before and was never that low again apart from a few days later in that year. And this was only two and a half years into the recovery from a long bear market that had seen a closing price in 1982 that was 7% below the price from 9 years prior. Over the next 15 years it reached many new highs only to keep going higher.
I also believe that a correction or a crash is possible. I would welcome that. As much as people say that the market is overpriced, I believe they would be even more afraid if it did crash again. This would just confirm their fears. They are more likely to buy in if it keeps rising and they see others making money.
With so many people still being scared of the stock market, I wonder how much further it has to rise before they believe that it is safe again. And I wonder how much higher they will push it once they do change their minds. If that’s what plays out it will be very expensive for investors who thought they were being cautious.
Ironically the level of fear these days in the media and on blogs sounds a lot like what everyone was saying in 2009. It’s a hard time to invest in stocks. But it just might be a good time.