Subject: RE: Questions for Sam Beard:"Investor's License"
>From: Michael Jones
>From James
>>>>It will reward all in the index equally.
>From Michael
>>>>The top stocks I was referring to are the high tech growth stocks. These stocks have accounted for most of the gains in the S&P500; over the past 5 years or so. Here's some of them, listing their 1998 returns: MSFT: 125% DELL: 220% EMC: 120% INTC: 75% WMT: 100%
Exactly my point. Since these stocks did not start out as the top 5 in market cap 5 years ago, indexing would have not rewarded them like the current market does. Their indexing 'return' would have been based on their relative market cap of 5 years ago. Not how an efficient market is supposed to work. Indexing does not reward current business decisions or earnings growth, but ONLY CURRENT SIZE!
>>>>However, modern indices do not weight companies equally anymore. They weight them based upon market cap. So, Microsoft has the largest weight because it has the largest market cap. When you buy the index fund, the largest chuck goes into Microsoft stock, in proportion to the market cap of Microsoft.
>>>>So, the growth stocks are rewarded in the index for their success.
But only if some other free market investment 'device' allows for that growth. Index investing does not. It tends to keep companies in their 'place' in a list defined by current market capitalization. Indexing is OK as a small percent of the market (like we currently have), but in a SS reform scheme, where a large percent of the market is owned by those retirement accounts in Index investments, that will overwhelm the ability of the 'rest' of the market to enforce 'stock prices based on performance'. Earnings (and P/E ratios) must matter, if the stock market is to be an efficient engine of economic growth. Indeed, a market not concerned with P/E ratios will rapidly lead to declining productivity. There is no incentive to provide profits (earnings) to 'owners' who don't care about them.
>>>>The index itself only returned about 30% last year. So there were many companies in the index which did not do as well that balance out the success of the top performers.
Exactly. But it wasn't the largest market cap companies that did the best. In an index investing environment, size is its own reward, not economic efficiency or productivity or earnings growth.
>>>>Well, this should be explained further. There is a decision
maker: the folks at Standard & Poors who own the index. They
have criteria that they use to determine which companies go
into the index. So they are the decision makers.
Yes. But the criteria has nothing to do with how well the business is run or what its prospects are. Only how big it is! If a company got to be the 100th largest in market cap, but then started to make poor business decisions, how would it be affected in an 'index' investing environment? Its market cap (and stock price) would continue to grow faster than the better run companies below it in the index, because index investing is based on its SIZE (market cap) not its performance! Not an efficient system. Indeed, if we had adopted this SS reform and indexing many years ago, all those growth stocks you listed would be much smaller. They became growth stocks based on how individual investors evaluated their PROSPECTS, not just how 'big' they were starting out.
You commented previously on how you didn't think there was any 'irrational exuberance' in the market. I'm not sure about the market itself, but your investment philosophy seems to be 'full' of it.
>>>>The last thing to recognize about a mania is its insidious nature. To quote Prechter: "A very human aspect of manias is that no prudent professional is perceived to add value to a clients investment experience. Indeed, the professional with the knowledge of history and value is evidently judged an impediment to success. The reason is that the investments that are the focus of the mania are widely accepted as the benchmark of normalcy. Therefore, only a professional who beats the benchmark is considered successful. As the focus of the mania narrows, this task becomes impossible. This is yet another difference between a normal bull market and a mania. In a bull market, professionals can add value relative to the benchmark, which is usually conservative (the short-term lending rate for instance). In a mania, no one can add value and that is the situation today."
Indeed, was that not your very point in regards to indexing, and that the P/E are just valued by the professionals (brokers and other experts) who need to 'get out of the way of the average investor' in your words? I think you need to review a good book on the free market economic system by a conservative economist. You don't understand the market mechanisms. If it was all as easy as putting money into index funds, the gov't could tax the people to raise the money to put into such indexes. Would this not guarantee economic growth if what you say is true? But it is never that easy. The free market requires an efficient mechanism, such as the current stock market and investor 'decisions', for evaluating 'winners' and 'losers'. Indexing won't do that. That you think it does, is a sign that the 'mania' has infected you.
>>>>As companies go, Microsoft is an unusual animal. They have relatively little "hard" assets. They do not pay a dividend. Objectively, Microsoft should not be valued as much as it is based purely on earnings. But earnings are not the whole picture.
But even though it isn't paying dividends, it does have earnings. Those earnings are re-invested in the company (or srored as cash belonging to the stockholders) to add to stockholder value. And it makes a big difference over time whether those earnings are a 4% or a 1% yield, since they are part of the engine of the company's growth. Current earnings are not the only consideration. But eventually, people will only invest in something that can return 'value'. There is no 'increasing value' in Microsoft if it can't produce increasing earnings (which it does). Indeed, there are a lot of 'untested' internet companies whose P/E ratios are a lot worse (that is higher) than Microsoft's by several orders of magnitude.
>>>>On the subject hindsight, I could give you investments right now that will be worth significantly more 5 years from now than they are today.
>>>Any of the companies listed above are good stocks. They all have top rate management and good business plans. There just aren't that many Michael Dell's, Bill Gates, etc. in the business world.
There is a vast difference between saying a company is good, or has good management, and saying it 'will be worth significantly more 5 years from now'. Even in bear markets, some companies are run a whole lot better than others. Doesn't mean the stock price will go up during a bear market. And who can forsee when a recession could happen. And who can forsee what the competition will bring. Many companies will attempt to 'copy' Dell's 'build computers on demand' process. Then Dell will loose that 'advantage' of how they structured their manufacturing and marketing process. It will get down to the much more mundane and nitty-gritty aspects of running a business, that are much more difficult to excel at by significant margins.
>From James
>>>>Beauracrats will not make any decisions, eligibility being
determined by the statute
>From Michael
>>>>Stop right there. I think I have made my point.
Hmmmm. The point must be that you cannot tell the difference between an unelected beaurecrat making discretionary decisions on his own and a duly elected legislative body creating statutes defining eligibility for means-tested programs. Very interesting.
>>>>The main point is that I can say with almost certainty what my investment return from Social Security will be. It's almost
"guaranteed" to be negative. There is not risk involved in this
investment. It's going to lose money for sure.
The problem with that analysis is the following. All the reaslistic reform plans include provisions for a means-tested saftey net, and provisions for life insurance and disability insurance replacements for the current SS plan. If you figure that all out, and it costs an average worker (regardless if its all 'taxes', or if the insurance is private) say about 4% of earnings, then they really would have only about 8.5% left to invest for retirement. Now, if you look at SS retirement payments, and look at the return based on only the 8.5% that is truly 'invested' in retirement, for many, the return will be positive. Indeed, it may be better than they could get investing themselves, without the risk. Regardless of whether they invest in stocks or gov't bonds. Not for everybody, certainly, but for many.
