Stock Market: It’s So 1900′s

Wall Street

Not Safe for Small Fish

Over the past few decades, the United States has embarked upon a course of massive financial market deregulation. This deregulation has affected every area of finance. The result has been a volatile and generally disadvantageous stock market for average investors. Conventional investment strategy dictates investing a large proportion of your retirement investments in the U.S. stock market, the remainder in foreign securities, bonds and fixed income investments. Generally, this amount is as high as 80% for someone in their twenties, to much less than 50% for someone nearing or already enjoying retirement. Conventional thinking has reached an end.

Recent deregulation, lax oversight by federal governmental regulators and law enforcement, increased barriers to individuals accessing the courts when disputes between investors and large investment houses, brokerages and banks arise has in my opinion made this strategy obsolete and dangerous. There can be no greater evidence of the breadth of the disingenuous concern for the individual investor than the dearth of prosecutions and meaningful statutory or regulatory fines imposed upon those who committed the fraud that caused the housing bubble and its ensuing tsunami of consequences. When fines are imposed or settlements reached with the perpetrators, it is often for a tiny fraction of the damage caused. For example, the most recent mortgage fraud settlement offers those whose homes were wrongfully foreclosed upon—repeat, wrongfully foreclosed–not simply foreclosed upon by mistake, but in cases of fraud, a lousy $2,000. The great fear is that upsetting Wall Street will prod it to unleash even greater harms upon us in return.

The bottom line is that no one is protecting you. You must protect yourself. The stock market—or should I say those who now control the stock market–have offered you nothing in the recent past for your adherence to the old adage of “invest for the long haul.” The market makers have done nothing but continue to gleefully accept your money through ridiculous fees in return for awful advice and poor returns. You have been nothing more than the basis for exorbitant leverage and a steady dependable stream of income. Your employers have not served you well either. Most 401K plans are riddled with fees and are far too light on low cost index fund options, further eating away at your already paltry returns. Your employers generally ignore their responsibility as fiduciaries. It is not a wonderful time to be an individual investor. For example, from 1996 through 2011, adjusted for inflation, the stock market overall returned nothing. Since the end of 1999, the return on United States equities has been 7.6 percentage points a year lower than that on government bonds. Dividend returns have consistently decreased for decades, and the long-term average annual return of the stock market has dwindled from historical averages as well. To be fair, there have always been periods in the past when stocks lagged behind government bonds for some period, but those events have been rare. In the modern era, these events are occurring more and more frequently.

This problem is only going to continue to grow as statutes and regulatory “reform” in the name of removing restrictions on growth loosens regulations further. The recent JOBS Act is an example. The act lessens regulations and reporting requirements on “emerging” businesses in the name of efficiency and ease of raising capital. What it actually creates is a ponzi scheme structure of separating investors from their money and a boiler-room mentality for business. As I discussed here, the reason United States equities  traded at such a high premium historically was a direct result of the perceived safety of these equities  due to stringent regulations and reporting requirements imposed upon publicly traded corporations. With many of these regulations removed, we will likely see greater and greater fluctuations in market prices and frequent significant drops in overall share price. This has always been the case in much of the developed world, where strict and meaningful regulations face powerful opposition by those in power.

Once the root cause of the recent housing market collapse and tangential market collapse had been ascertained–lax oversight, deregulation, excessive leverage and derivatives trading–the rational response should have been to rewind the regulatory environment back to the posture it had occupied prior to the irresponsible behavior, or at minimum to set a path toward that end. However, the United States did not, and it did not precisely because both the Democratic and Republican parties are in the pockets of Wall Street. Whether the election financing rules have contributed to this situation is certainly an important discussion to undertake, but it has no relevance to your investment strategy at this time. President Reagan began the process of financial market deregulation and it reached its crescendo under President Clinton and President Bush. Money ruled over ideology, and we all paid for their incompetence.

As I write this the DOW Jones Industrial Average is above 13,000, riding high on recent jobs numbers and clues from the Federal Reserve that more easy cash is on the way. But mark my words, the economy has not been fixed, and the recent financial regulations passed by Congress and signed by President Obama do little to decrease the likelihood of another catastrophic event. Until meaningful regulation is enacted and the governmental agencies charged with investigation and prosecution of fraud and violations of even existing rules do their jobs effectively, the stock market offers you no better security or growth than a craps table.

The time is now to rethink your overall investment strategy and shift toward a portfolio weighted more heavily toward government securities, high quality corporate bonds, savings bonds, foreign government bonds of stable nations, domestic municipal securities, and even certificates of deposit. The money you do have invested in the stock market should be in low fee index funds, not in any fund managed by some pimple faced Harvard MBA. Less than 1% of these funds’ managers have outperformed the market even when times were great and stable! If they did outperform, it was due to nothing more than dumb luck.

Investing in the stock market for the long haul may have been sound advice in the past, but it no longer holds true. I would go even further than many who subscribe to low fee index fund investing in that I believe that investing a traditionally acceptable percentage of a portfolio in low fee stock index funds, as the stock market portion, is far too volatile and risky. I believe a portfolio that your grandmother may have held is more appropriate now. You may have heard her say “at least I didn’t lose money” many times, and she may nave been right, absent inflation. She would have made more money by investing in the stock market, you likely will not. A portfolio heavily weighted toward safe fixed income securities is just what she would recommend, and in 2012, she’s right. I do not anticipate a reversion to a financial regulatory environment safe for individual investors anytime soon. If the recent crash could not nudge policymakers in that direction, I do not know what will. The only path back to sanity lies with the electorate in voicing its demands in the voting booth.