Monday, February 16, 2009

Is the Stock Market a Ponzi Scheme? Part 2

In November of 2002 Dan Goldstein wrote The Stock Market as a Ponzi Scheme: FAQs.

In May of 2004 Dave Pollard wrote The Stock Market as a Ponzi Scheme."

What is especially interesting to me is that both were written several years before the recent "bubble burst." What do you think? What is wrong with the arguments these guys are giving? Or are they right? Again, please 'splain it to me.


collin said...

Beth, I'm afraid that they are right as far as their arguments go. But here's the question: what are we going to do about it? What is prudent -- to invest only in bonds and short-term debt?

Blodget does a terrific job of explaining at least part of the crash in this great article by Blodget in the Dec'08 Atlantic.

Let me ask his question, which is like the question I asked above. Suppose you're a fund manager and you see stocks like amazon and google rising. In your heart you know the prices are too high, but the prices keep rising! Your boss says you have to put clients' money into those stocks so that the returns won't lag "everybody" else's.

What do you do? Keep clients' money out of those absurd stocks and get fired? Put clients' money into those stocks, contributing to the bubble -- and to the coming crash?

And as individual "investor"s, what's prudent? Stay out of equities altogether?

The other thing is this: What if what you "know in your heart" just isn't true? Consider this from Blodget:

Consider, for instance, the late 1950s, when a tried-and-true “sell signal” started flashing on Wall Street. For the first time in years, stock prices had risen so high that the dividend yield on stocks had fallen below the coupon yield on bonds. To anyone who had been around for a while, this seemed ridiculous: stocks are riskier than bonds, so a rational buyer must be paid more to own them. Wise, experienced investors sold their stocks and waited for this obvious mispricing to correct itself. They’re still waiting. (that's from part 2 of the article).

Yes, the stock market is a gamble. Will the birth rate keep the market rising over the next couple of decades? Probably. Need we worry about the retirement of the boomer generation, and how it'll pull billions out of the equities markets?

No -- the boomers didn't save very much at all and hence didn't have much in the equities markets.

I suspect ours might be the last generation that can profit in the market. For my children, though, I'm not sure....

Beth B said...

Thanks, Collin, for your response. That Blodgett article was indeed helpful.

Great lines:
"But most bubbles are the product of more than just bad faith, or incompetence, or rank stupidity; the interaction of human psychology with a market economy practically ensures that they will form. In this sense, bubbles are perfectly rational—or at least they’re a rational and unavoidable by-product of capitalism (which, as Winston Churchill might have said, is the worst economic system on the planet except for all the others). Technology and circumstances change, but the human animal doesn’t. And markets are ultimately about people."