The Market is Just not into Main Street Anymore

Throughout 2010, and for the last decade, equity returns have produced practically nothing for all its troubles. Then, why do investors continue tolerating an insane amount of volatility and risk of principal, for punk rewards - we are holding on to a once profitable relationship that no longer exists.

There; it had to be said.

This 30-year affair between the American middle class and financial markets has been counterproductive over the previous decade. Analysts and money managers are like your mate‟s best friend who looks straight into your eyes and lie to your face. “The relationship is fine.” “You are imagining things.” “Every relationship has its highs and lows; you two are experiencing a temporary low period, that‟s all.” “You think you could do better without her?”

Wall Street was a rich man‟s playground - until the inflationary 1970„s. At that point, the rich stop buying stocks. P/Es on stocks fell to hat size levels. Prior to the stagflation and inflationary 1970‟s, it mattered little that commissions were fixed and burley. The last secular bill market ran from 1950 to 1965. Potential brokers were invited and groomed, by white shoe firms, to introduce themselves to and to form relationships, with the affluent.

In 1962, self-employed individuals or unincorporated businesses became eligible to self-direct retirement accounts through Congressional legislation with the establishment of (Eugene) Keogh or HR (10) plans. Twenty years later, employers asked the same question, differently: Why shouldn‟t employees have the same freedom to self-direct their retirement account (thereby, removing corporate responsibility for employees‟ retirement).

The private sector, as late as the early 1980‟s, offered new workers employer-sponsored defined benefit (DB) retirement plans. Investment risk and portfolio management are entirely controlled by the company. Payouts are calculated on factors such as salary and duration of employment. If there is a short-fall on investment returns, companies are obligated to dip into earnings to cover the difference.

Luckily, for corporations, bottom line margins and much of today‟s $1.6 trillion in cash, sitting on the balance sheets of corporations, is safe from being encumbered by DB plans and their retirees.

DB plans are still owned by many public sector workers. Currently, these plans are routinely vilified in the press as parasitic in nature. Defined Contribution (DC) retirement plans, enthusiastically launched in the 1980‟s as DB plan‟s chief competitive product, and were sold primarily by ridiculing DB plans as being inferior to self-directed accounts. DC plans‟ major weakness, an unknown future payout to retirees, became its major marketing strength.

Men with ambition, real men, theoretically, could make untold millions playing the stock market. Accepting a DB plan‟s corset over unlimited retirement income potential was the providence of the dull-witted or the lazy, lacking in motivation, vision and imagination.

The tiny requirements for raking in bushels of filthy lucre, for your golden years, as the pitch went, were reading Peter Lynch books and by faithfully watching Louis Rukeyser‟s Wall Street Week; “as you know, over time, all stocks increase in value.”

Because of the internal logic of DC plans‟ supposition from 1980‟s Wall Street, it was antithetical for Human Resource departments and mutual fund companies to argue, at the beginning of a secular bull market, in favor of capping pedestrian, formulaic, DB plan payouts. Unrestricted, free market-based, DC plans were vastly superior on every count.

Beside, where did DB plans‟ returns really come from? They came from the stock market! Eliminate the middle man; keep for yourself all the returns your hard earned dollars generate in the stock market. Mr. Hare, meet Mr. Tortoise.

The accelerants fomenting this new mindset, when stocks such as Boeing, Walt Disney, Mattel, and many others, sold for $5 dollars a share or less, were de-regulated commissions, Merrill Lynch‟s new Money Market Account, and Sears acquisition of Dean, Witter, Reynolds (now Morgan Stanley). Additionally, declining inflation and interest rates, tax cuts, and deficit spending, helped deliver to Wall Street the middle class aspiration of champagne wishes and caviar dreams.

Over the next 20 years it was a world wind affair with unbridled infatuation. Mutual fund sales loads were cut from 8.5 per cent to 4.5 per cent. Exchange privileges inside mutual fund complexes were established. Letters of Intent, reducing sales fees further, became standard. Investors began choosing stock investments over precious metals, over real estate, over all other asset classes.

Stock market DC plans, became the preferred method of saving for retirement. Dividend Reinvestment Plans (DRIP) and stock purchase plans, compounding returns, also became more popular, adding fuel to the roaring stock market fire. Owning equities were touted by every financial services company. Consequently, more workers chose DB plans, year after year, playing at the big boys table.

Fictional character Gordon Gecko became the Pontiff of American financial idolatry and fictional prosperity. In the late 1980‟s, banks begin selling mutual funds and insurance; and vice versa. Charles Schwab introduced the no load mutual fund. Fund companies created A, B, C, and D shares, offering various sales load configurations.

In the 1990‟s, everyone made money playing the stock market. The beginning of online trading even made it easy to do. The WSJ ran a recurring article featuring a chimp throwing darts, selecting stocks, and comparing his returns with professional money managers. That‟s when you know you are in a secular bull market.

Yes, we were so in love with each other. Then, dark clouds appeared and forever changed the future – Glass-Steagall was repealed.

Early in the next decade, Wall Street‟s wandering eyes caught a glimpse of augmented proprietary trading and underwriting fees. Enhanced leverage, donning smaller and more provocative capital reserves, heretofore, disapproved of among prudent men, became desirable and lusted after by all. Scandalous risk was in vogue.

Investors‟ trading commissions and management fees were a competent and faithful, if somewhat, plain way for firms to earn revenue. It was like home cooking five nights a week and backyard grilling on the weekends – safe, predictable, fulfilling, and bland.

Conversely, trading the firm‟s capital and collecting securitization fees was the long-legged, redheaded, man-eating, gorgeous knockout, swinging from your arm each night, walking into your favorite hangouts.

Once Wall Street felt the rush from mainlining mortgage-backed securities the relationship with John and Jane Q. Public was doomed.

Any hope of salvaging this fraying union ended in 2008. We were unsuccessful in getting American finance off the narcotic of toxic assets; kicking this addiction to fast money, infinite fees and profits, and nympholeptic bonuses. A clean and sober banking system, facing tough new regulations, would function properly, yet again.

Regrettably, the wrong crowd appeared offering help – Buffett, Paulson, Geithner, Blankfein, Bernanke, and Geithner – peddling TARP, Quantitative Easing, credit facilities, and government guarantees.

Immediately, overnight loan orgies were being held at the Feds‟ discount window. The decency of mark-to-market accounting was scoffed at and ignored. Banking hedonism ran amuck on the streets of Manhattan and through the halls of Congress. Someone had shot the sheriff and the deputy, too.

It‟s over. In a world of globalization, high frequency trading, melt-ups, flash-crashes, and algorithms, Wall Street doesn‟t need the American middle class anymore; the stock market was up 7 per cent in July despite the fact that equity mutual funds experienced outflows in each of the last 12 weeks.

Wall Street now borrows pure, uncut, scratch – at 0 per cent - directly from Mr. Big; Washington DC. Treasury auctions are co-dependent enablers of this bankrupt practice. There is no turning back. Investors will make the wrong choice during a flash crash or flash bounce and will lose.

Somehow, that someone is always John and Jane Q. Public.

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