| The Sum Also Rises PARIS, FRANCE MONDAY, 15 NOVEMBER 1999 * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *
In Today's Daily Reckoning: *** All the major indexes were up *** An apology 900 years overdue *** Investors still expect impossible returns * * * * * * * * * * * * * * * * * * * * * * * * * * * * * * *** A good week for Wall Street. All the major
indexes were up a bit. Friday, the Dow rose a big 173
points. Transports, Utilities…everything was up. *** But the rise in the indexes continues to mask
the fact that most stocks are still going down.
Though there has been some broadening in the
market, there were 186 new highs last week against 341
new lows. On Friday, despite the big move up, there
were only 70 new highs compared to 120 new lows. *** Could the market broaden out…and a genuine
new Bull take over? Yep, sure could. But that's not
what happened in 1929, 1973, 1987 or 1990.
After a period of divergence, the indexes fell sharply to
catch up to the broader market. That is what will
most likely happen this time, too. *** Leading Friday's Wall Street boom were the
financial stocks, free at last from the restrictions
of the Glass- Steagall Act. Investors expect a
wave of mergers and acquisitions that will lift stock
prices. This is, of course, all nonsense. The
financial sector is already extremely competitive. It
will be a rare company that actually makes more
money because of a merger…more on the financial
industry and what it really costs investors…below… *** The dollar rose Friday. Money is still flowing
into the United States. The euro is edging down
towards 1 for 1 parity with the dollar. *** Gold fell by $2.80. Still waiting… *** Credit Suisse First Boston reports that stocks
now make up to 60% of household financial assets.
Households own $7 trillion directly…40% of the entire
market. The average stockholder is 47 years
old…with a household income of $60,000…and
assets of $85,000. *** James Passin reports that Russian stocks have
gained 90% this year. But that still means that the
value of every publicly traded company in Russia,
added together, is worth less than Amazon.com. *** More on the personal toll of WWI…from a
French DR reader…below… *** Friday's "Figaro" newspaper reported that the pope,
no doubt moved by the popular spirit of
confession, repentance and forgiveness, was going
to apologize, on behalf of Christendom, for the
Crusades! Long overdue, of course. Other apologies
to look for: Italy should apologize to Tunisia for
the destruction of Carthage by the Romans in 146 B.C….
China should issue a word of regret for the
13th century Mongol invasions of Europe…and
someone should issue a mea culpa on behalf of Homo
sapiens for the extinction of Neanderthal man.
We don't know for sure that Cro-Magnon man was
responsible…but we might as well own up and take
the rap anyway, because the other possible
culprits have been dead for 50,000 years. *** A headline in the "Herald Tribune" tells us that
George W. Bush is going to focus his foreign
policy program on large countries that are easy to
remember. The media believe it is important that
presidential candidates know the names of other
politicos in other countries. But what possible
difference could it make? Ignorance of politics…both
local and international…should be a
requirement for any person running for public office.
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THE SUM ALSO RISES
You don't have to be a politician to lie. Take the
financial industry, for example. I wrote to you on Friday with Warren Buffett's views
on the stock market. But there was something
else in his "Fortune" article that deserves attention. In fact, it is staggering. Much is made of the fact that the stock market is
not a zero sum game. Unlike poker, currencies or
professional wrestling…there doesn't have to be a
loser for every winner. This leads to the
illusion that we can all be winners. How else to account for the popularity of index funds?
Investors must believe that it is possible for
all investors to make money…just by all being
invested in the popular stocks. Which is exactly what
they do believe. A survey I just read this morning…
new ones come out all the time…found that the
average investor expects a return of 16% per annum
for the next 10 years. They think the entire
market will rise by 16%…not just that they will get
lucky and find the few stocks that will
compound at that rate. New investors, those who have
been investing less than five years, expect
returns of 22.6%. Buffet points out that "investors as a whole cannot get
anything out of their businesses except what
the businesses earn." Investing is not a zero sum game…
but the sum is not infinite either. It's the
sum of business earnings. As a percentage of GDP, only
occasionally have business profits exceeded 8%
during this century. Usually they are between 4% and 6%…
or about 5% on average. They are unlikely
to go much higher. Businesses compete for profits.
High profits draw in additional investment and
additional competition…which causes the profits to
regress to the mean. As a group, investors can only expect to make what
the stocks themselves make. They are the owners of
businesses. The businesses can expect to earn about 5%
profits, after tax. Investors can, therefore,
expect to earn about 5%, too…some of it in dividends
and some in capital gains.
Yet investors believe that by trading the stocks among
themselves…somehow they become more
valuable. But imagine the whole group of investors as
just two people on an island. They have a
company that makes money by selling beads to
passing cruise ships…earning about 5% profit each
year. They can sell the shares back and forth all they
want…but the business still only produces
the same 5%. "The absolute most that the owners
of a business, in aggregate can get out of it in the
end -- between now and Judgement Day," says Buffett,
"is what that business earns over time." So, the upside, for the group as a whole, is limited.
By profits…and profits are limited by
competition.
The only way to do better is to beat the averages.
And it is to that end, obviously, that investors
buy and sell shares…and the financial industry --
which rose so mightily on Friday -- labors day
and night. Obviously, buying and selling results in some investors
doing better than the market as a whole…and
some doing worse. But what does it do to the whole
group of investors? What does it do the sum, said
to be greater than zero, which elevates investing above,
say, shooting craps as a means of increasing
one's net worth? The financial industry is expensive.
It is not for nothing that houses in the
Hamptons have soared in price…and the yacht
industry is in the middle of a huge boom. Buffett examines the cost of the financial industry.
The "friction costs," he says, "are for a wide
range of items. There's the market maker's spread,
and commissions, and sales loads, and 12b-1 fees,
and wrap fees, and even subscriptions to financial
publications [an insignificant item in the grand
scheme of things…and well worth the money,
of course]. And don't brush off these expenses as
irrelevancies…" Readers may point out that competition in the
financial industry is driving down transaction costs.
American Express is taking the lead, offering Free
Trades. But there is small print…you have to
keep an account balance of at least $100,000.
Customers with less than $100,000 but more than $25,000
are allowed to buy stocks without paying a commission…
but selling it requires payment of $14.95.
E*Trade is paying customers to set up an account.
Ameritrade is offering a free trip to Hawaii or
London. But it still costs the brokerage houses between
$8 and $25 to execute a stock transaction. And
they've got to make money somehow…even in
a post-capitalist world. "How do they charge thee," asks
Buffett, "let me count the ways. Start with
transaction costs, including commissions, the market
maker's take and the spread on underwritten offerings." How much do all these expenses add up to?
Buffett believes investors pay "well over $100 billion a
year…say $130 billion…to move around those
[stocks] or buy advice about whether they should!" Meanwhile, extrapolating from Buffett's figures,
investors have only about $450 billion of earnings
to begin with. Subtract the brokers' yachts and
limousines, and you're taking off more than a quarter
of the potential gain. The sum gets a little closer
to zero. Take out 2% for the inflation rate, and
investors can reasonably expect less than 3%
of real gain, net of "friction" expenses.
You're not likely to earn 22%…or even 16%… …but, as Hemingway put it, isn't it pretty to think
so? Regards from your faithful correspondent in Paris..
.where I will raise a glass at one of Papa's
favorite cafes, the nearby Les Deux Maggots,
in his memory. Bill Bonner
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COMMENT ON THE GREAT WAR
Cher Bill, I don't know what new paradigm was born in
WWI. But I know that my grandfather -- my mother's father
-- was killed at Verdun in 1917, that his widow
died from the "Spanish Flu" (an epidemic born in the
war and that caused almost as many deaths) in 1918,
and that my mother, orphaned at 14 years old, had
to go to work immediately in order to support herself.
That made her what she was and determined how
she raised and educated me, and today…despite
everything that I've learned and thought…there is
something of WWI still in me, even if it has been forgotten
by history and the media. There are
things that last a lot longer than we see… As for the Internet…I don't know anyone in Paris who
uses it regularly…and in Perche [a rural
area about one and a half hours from Paris] the Internet
might as well be a UFO. The Internet is not WWI. It is not a revolution. It is just a tool. Michel | 
