hocus's puzzle

Financial Independence/Retire Early -- Learn How!
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

hocus's puzzle

Post by JWR1945 »

hocus's puzzle

On the The purpose of SWR analysis thread, hocus has asked the question: Since there are both a buyer and a seller for each share of stock held, where does the other side of each sale come from? As the middle class has moved into and out of the stock market over time, pushing prices up and pulling them down, how is the balance maintained? Specifically, who is on the other side of each transaction?

I replied. I knew that I was not answering hocus's question but I did supply some information. hocus noted that part of my reply middle class retirees was new and interesting.

As I have reflected further on his question...hocus calls it a puzzle, I have realized that an answer could be of great benefit to all of us. It could help us project the future performance of the stock market.

To be even more specific, we know that the current valuation of the S&P 500 index as measured by P/E10 is at the top of its historical range. (P/E10 is the value of the index...or price...divided by the average of the previous ten years of earnings). It has fallen dramatically from its peak. But it is still at the high end prior to the bubble years. It is highly relevant for us to know whether it will drop further or whether it will remain elevated. From one perspective in order to avoid saying that it is different this time we would predict that it will continue to fall.

If we think in terms of the people who actually own stock, we could easily conclude that it will not. Many of the current owners are in the middle class, among the baby boom generation and saving for retirement. Others are in retirement already. To avoid saying that It is different this time we would focus on the behavior of people who are investing for retirement or who are already in retirement. These groups may stay in the market because they do not look at it primarily as gambling or speculation. They look at it as investing.

I invite others to come forth with their thoughts on this. Again, the benefits of looking into this issue are enormous. Do not feel shy. It could be that a person who errs greatly could be the hero who unlocks this puzzle. We could discover an important hidden truth in the process of exposing the error. Knowing the reason behind any error is valuable.

Again, I am on record as saying that I do not know the answer. I think that all suggestions are valuable.

Have fun.

John R.
TRyan
* Rookie
Posts: 40
Joined: Tue Dec 17, 2002 3:00 am

Post by TRyan »

I am puzzeled ... Wouldn't the market swings simply be the middle classes impact on itself.

The financial institutions are using the middle class $$ (401k, pension, 403D ...) The average joe-6-pack is not day trader. In fact he works a job which would simple not permit him to even track his portfolio daily.

He simply waits for his quarterly statement and - for the last 3 years - even largely ignores that.

I think the slow roll downhill has been prolonged by the feds lowering interest rates and - perhaps more significantly - joe-6-pack refusing to acknowledge his losses.

But the question of who is on the "other-side" of the middle class buy/sell... I believe is the middle class sell/buy. The larger mob-mentality dictates market direction.
"Buy Low Sell High"
User avatar
ataloss
**** Heavy Hitter
Posts: 559
Joined: Mon Nov 25, 2002 3:00 am

Post by ataloss »

With a larger than usual number of people are in their peak earning years saving for retirement there is upward pressure on stock prices since these people are likely net buyers of equities. It will be interesting to see what happens when the population bulge ages and these investors sell. The smaller size of the succeeding group means that there will be relatively fewer sellers (and likely depressed prices.)

ataloss
waiting for the veiex viper
Have fun.

Ataloss
hocus
Moderator
Posts: 435
Joined: Mon Dec 02, 2002 12:56 am

Post by hocus »

The question of who is on the "other-side" of the middle class buy/sell... I believe is the middle class sell/buy. The larger mob-mentality dictates market direction.

This is the way it is ordinrily portrayed, TRyan. But is it so?

Say that in the next year the DOW goes down another 2,000 points. Commentators will be commenting that middle-class investors threw in the towel and lowered their allocations and so on. Fine. A decision by middle-class investors to lower their allocations would indeed represent a lessening of demand for stocks and would cause a lowering of prices.

Still, for each share sold during the 2000 point drop, there would be a share purchased by someone else. If shares simply circulated from one middle-class person to another, the percentage of stocks owned by the middle-class as an overall entity would never change. My understanding is that it does change, that the middle class increases its ownership share during bull markets and lowers it during bear markets.

The question is, when middle-class workers sell, who is doing the buying? Who is on the other side of the transaction?

One very tentative theory put forward on the other thread ("The Purpose of SWRs") was that it is wealthy investors. Another very tentative theory was that it is middle-class retirees. When middle-class investors as a group sell, someone is buying. Who is it?
User avatar
BenSolar
*** Veteran
Posts: 242
Joined: Mon Nov 25, 2002 5:46 am
Location: Western NC

Post by BenSolar »

ataloss wrote: With a larger than usual number of people are in their peak earning years saving for retirement there is upward pressure on stock prices since these people are likely net buyers of equities. It will be interesting to see what happens when the population bulge ages and these investors sell. The smaller size of the succeeding group means that there will be relatively fewer sellers (and likely depressed prices.)

I believe there is merit in looking at the boomer demographics, but I think we need to distinguish between categories of 'equities'. In the recent past 'equities' has meant the S&P 500, I think. However, as the boomers absorb losses, and these losses and the shortening time until retirement sinks in, they will naturally search for ways to protect themselves from further losses.

One way to do this is to shun stocks entirely, which some may chose to do. Probably more will chose to diversify away from a concentration in large cap growth. I think tons of people have the bulk of their 401ks in Magellan or an S&P 500 index. I think we will continue to see allocation away from large cap US stocks and into other vehicles like bonds, REITs, international stocks, small cap stocks, MMFs and CDs.

Once burned, twice shy, you know. People will get fed up with the losses and move away from the pain eventually. I heard a lot of talk around my office when the 3rd quarter 401k balances came out. Not too much reallocation at that time, but people were talking about their losses. Those were recouped a bit before the most recent statement, but I do believe we will see a broader awakening of the middle class 401k investor to the pain and losses if we revisit and/or surpass the October lows.

I tend to think the bubble / crash cycle will prove to be the dominant force over the next few years rather than the demographics. The demographics may cause the crash to be in slower motion than otherwise, though.

Ben

PS I don't really have a clue what will happen, but valuations sure are still high.
Last edited by BenSolar on Fri Jan 24, 2003 6:51 pm, edited 1 time in total.
"Do not spoil what you have by desiring what you have not; remember that what you now have was once among the things only hoped for." - Epicurus
User avatar
BenSolar
*** Veteran
Posts: 242
Joined: Mon Nov 25, 2002 5:46 am
Location: Western NC

Post by BenSolar »

hocus wrote:
The question is, when middle-class workers sell, who is doing the buying? Who is on the other side of the transaction?

One very tentative theory put forward on the other thread ("The Purpose of SWRs") was that it is wealthy investors. Another very tentative theory was that it is middle-class retirees. When middle-class investors as a group sell, someone is buying. Who is it?

Random thoughts on the subject:

- Middle class retirees: if we are talking about FIREees, then they would likely fall into the classification of 'wealthy investors'. Traditional middle class retirees are more likely to be net sellers of stocks than buyers, I think.

- Wealthy savvy investors are likely rebalancing and buying stocks as a bear progresses, so that is one source of buyers, I think.

- Older wealthy investors are most likely to have experienced a bear / bull cycle before as stock owners, and so will be best prepared to weather the storm and have money to buy as valuations get more attractive.

- Pension funds and endowments are likely buyers in a bear, as they are likely to have an allocation plan and stick to it by rebalancing. IMO

Ben
"Do not spoil what you have by desiring what you have not; remember that what you now have was once among the things only hoped for." - Epicurus
WiseNLucky
** Regular
Posts: 84
Joined: Tue Nov 26, 2002 3:59 am
Location: Florida

Post by WiseNLucky »

I tend to think the bubble / crash cycle will prove to be the dominant force over the next few years rather than the demographics. The demographics may cause the crash to be in slower motion than otherwise, though.


You make a very good point here.

Bernstein argued for the importance of demographics, because retirees will be selling, whether there are buyers or not. Prices will be forced down, just like they have been forced up in the 80s and 90s.

But the bubble got so BIG! A crash was inevitable, despite lots of new money coming into the market due to demographics.

And if we have a 70s style bear, lots of people will be scared out of equities permanently. I wonder as a boomer if there will ever be upward pressure to make my accumulation worthwhile. I don't know, but I intend to hold out as long as I can.

I keep seeing statistics of buyers during bear markets being winners in the end. Can it be different this time?

WiseNLucky

PS: I am really enjoying this board!!!
WiseNLucky

I just wish everyone could step back and get less car and less house then they want, and realize they don't NEED more. -- NeuroFool
User avatar
ataloss
**** Heavy Hitter
Posts: 559
Joined: Mon Nov 25, 2002 3:00 am

Post by ataloss »

I keep seeing statistics of buyers during bear markets being winners in the end. Can it be different this time?


unprecedented valuations at the peak of the bull and (perhaps) at the bottom of the bear market suggest that it could be different. With the average managed fund having 100% turnover and many "long term" investors churning their portfolios I see no reason not to believe that the middle class is largely exchanging stocks with each other.

I think there is the demographic effect with a superimposed (now deflated) tech bubble.
Have fun.

Ataloss
User avatar
BenSolar
*** Veteran
Posts: 242
Joined: Mon Nov 25, 2002 5:46 am
Location: Western NC

Post by BenSolar »

WiseNLucky wrote: PS: I am really enjoying this board!!!


Me too!! :D
I wrote: Pension funds and endowments are likely buyers in a bear, as they are likely to have an allocation plan and stick to it by rebalancing. IMO

On further thought, these two will be huge consumers of stock shares in a deflated market. They have immense incoming cash to deploy on a regular basis. Even a conservative allocation of incoming cash to stocks will consume huge numbers of deflated shares.

Endowments are getting to be ridiculously huge! College endowments were $222 billion in June 2002. :shock:That's down from $236 billion in 2001.
NASFAA wrote: the average asset class compositions of all participants are divided among equities, 57.4%; fixed income, 26.9%; hedge funds, 5.1%; cash, 3.9%; and real estate, 2.7%. The remaining categories venture capital, private equity, natural resources, and other represent the remaining 4.0%.


On the other hand, I guess if demographics go against pension funds then maybe they turn into net sellers too? Ouchee. :( Fear driven sales combined with demographic driven sales from boomer retirees and their pension funds forced to sell to pay out benefits. Sounds possible.

Well, I have to say, I'd like to be able to invest in the markets with the valuation below average. 8)

Ben
"Do not spoil what you have by desiring what you have not; remember that what you now have was once among the things only hoped for." - Epicurus
andrew61
* Rookie
Posts: 2
Joined: Thu Dec 05, 2002 1:26 am
Location: Chicago, IL USA

Post by andrew61 »

The financial institutions are using the middle class $$ (401k, pension, 403D ...) The average joe-6-pack is not day trader. In fact he works a job which would simple not permit him to even track his portfolio daily.


Not necessarily. My 401k from my previous employer updates account balances regularly after the close of each market day. I can track my total account balance, as well as my various fund balances, daily online or by telephone. It takes me all of two minutes per day, if that.

I can't "day trade" with my account, but I can periodically switch money from one fund to another. Mine lets me do this up to four times per quarter. If I were still employed and contributing new money, I could also change my investment direction.

Are higher average P/Es justified going forward, on the assumption that most middle-class workers will stay invested in stocks long-term through their 401k's, and will continue to invest in more stocks? Personally, I think that assumption is very iffy.

I personally know several people who've recently told me they've gone into their 401k accounts, and switched their money out of stock funds and into bond funds. I'm hearing a lot of this lately. To me this is evidence that some are no longer buying the "long term buy and hold" line after seeing three straight years of losses. Some are bailing out -- the only question is how many? And will that trend accelerate over the next few years? My guess is that the bear market still has a long way to run before we hit bottom -- and that the fall will be in agonizing slow motion. I'd much prefer to get it over with quickly, but I don't see that in the cards. It will take a while for the majority of middle-class 401k investors to finally capitulate, but they're slowly catching on. JMHO.
WiseNLucky
** Regular
Posts: 84
Joined: Tue Nov 26, 2002 3:59 am
Location: Florida

Post by WiseNLucky »

I personally know several people who've recently told me they've gone into their 401k accounts, and switched their money out of stock funds and into bond funds. I'm hearing a lot of this lately. To me this is evidence that some are no longer buying the "long term buy and hold" line after seeing three straight years of losses. Some are bailing out


Excellent point.

With bonds at such high prices right now, however, I wonder if these people aren't jumping from the frying pan into the fire. The time to have made that move was 2000. If there is a such thing as a bond bubble, we must be entering it or already in it.

I believe this behavior is performance chasing no different than those who jumped into equities for the first time in 2000 and 2001, or those who moved from equity fund to equity fund AFTER each fund had a run-up. And the results could be the same if we enter a recovery and the fed quickly moves to raise interest rates off of 30 year lows. A prime example of investors receiving worse returns than the market as a whole.

My concern is that bonds and equities are currently richly priced, leaving only cash as a viable investment option. But, as my friend wanderer reminds all of us, cash is an asset class.

That's also why we are hearing so much discussion of real estate on this board. But my personal feeling is that we have already experienced a sharp run-up in real estate prices as well, at least in my neck of the woods. And I personally have no interest in non-local direct real estate investment outside of my VGSIX. How wanderer has the courage to do this I'll never understand. Of course, courage is the first rule in successful investment strategies.

So I take comfort in trying to move as best I can against the herd. Unfortunately, the herd is mulling around with a confused look on its face at present.

WiseNLucky
WiseNLucky

I just wish everyone could step back and get less car and less house then they want, and realize they don't NEED more. -- NeuroFool
raysk
* Rookie
Posts: 5
Joined: Fri Dec 20, 2002 3:00 am
Location: Lagrange,OH

Post by raysk »

Most individual investors make thier moves AFTER the fact.That's why so many wind up buying high and selling low.
As far as investment advisors go,I believe that monkeys throwing darts are still a step ahead of them.
There are always segments of the market that shine,even during a bear.With our fallng dollar,international bond funds are doing very well today as are certain funds that focus on China.These types of funds do very well till the talking heads notice them.When the herd follows it's time to start watching very carefully for an exit point.
2002 was my only down year since 1994.My portfolio dropped 4.11%,mostly my own stubborn fault as I misread a few signals.
There is some good dough to be made this year without a lot of risk or getting into metals.Gold is starting to remind me of 1999 tech.It may have a lot of upside left but when it falls it falls fast.
Easterm Europe could possibly be big as the governments stabilize
and more business come open to investment.
Looking for a GREAT 2003.
Ray
JWR1945
***** Legend
Posts: 1697
Joined: Tue Nov 26, 2002 3:59 am
Location: Crestview, Florida

Post by JWR1945 »

more about hocus's puzzle

From BenSolar:
PS I don't really have a clue what will happen, but valuations sure are still high.

Since I also fall into the don't have a clue category, I can say anything with impunity.
I think that there is now a core group of middle class investors that will stay in the market. These are the people who have been in for a decade or more. They (we) are still ahead. hocus and others have mentioned this at times. It is psychological.

BenSolar alludes to this when he says:
Older wealthy investors are most likely to have experienced a bear / bull cycle before as stock owners, and so will be best prepared to weather the storm and have money to buy as valuations get more attractive.

From WiseNLucky
And if we have a 70s style bear, lots of people will be scared out of equities permanently. I wonder as a boomer if there will ever be upward pressure to make my accumulation worthwhile. I don't know, but I intend to hold out as long as I can.
From Andrew61
Are higher average P/Es justified going forward, on the assumption that most middle-class workers will stay invested in stocks long-term through their 401k's, and will continue to invest in more stocks? Personally, I think that assumption is very iffy.

I think that a large percentage of middle class investors will stay. The experienced and the stubborn. Others will leave. They are the ones who are new and who have been burned badly in the last few years.

I think that allocations will change along the lines suggested by BenSolar:
One way to do this is to shun stocks entirely, which some may choose to do. Probably more will chose to diversify away from a concentration in large cap growth. I think tons of people have the bulk of their 401ks in Magellan or an S&P 500 index. I think we will continue to see allocation away from large cap US stocks and into other vehicles like bonds, REITs, international stocks, small cap stocks, MMFs and CDs.

From WiseNLucky:
Bernstein argued for the importance of demographics, because retirees will be selling, whether there are buyers or not. Prices will be forced down, just like they have been forced up in the 80s and 90s.

I do not think that this is necessarily true...at least, not to the extent anticipated. My guess (remember...as long as I don't have a clue, I can say anything) is that many retirees will try to live on dividends alone without selling stocks and they will be successful. We have seen more and more people favor such an approach, both on this board and elsewhere. Many will want to pass their stock holdings to their heirs and to their favorite charities...in spite of what the bumper stickers say.

OTOH, I do remember hearing a person say that he wanted to stay in stocks until just before all of the baby boomers begin making withdrawals. That was almost ten years ago. There certainly could be selling panics along the way.

Remember also that corporate America is an extremely powerful wealth-generating machine. Remember as well that...if demographics make local investments unattractive...our investment opportunities do not evaporate. There will always be talented, young people abroad to invest in and who would appreciate an opportunity to succeed.

In terms of what hocus is after, I think that many of the buyers will be middle class investors (or who will have started out as middle class investors) who are still ahead substantially...in spite of the last three years.

WiseNLucky said it best:
PS: I am really enjoying this board!!!

That much I know. Otherwise, I haven't got a clue.

Have fun.

John R.
User avatar
ataloss
**** Heavy Hitter
Posts: 559
Joined: Mon Nov 25, 2002 3:00 am

Post by ataloss »

Remember also that corporate America is an extremely powerful wealth-generating machine. Remember as well that...if demographics make local investments unattractive...our investment opportunities do not evaporate.

I am sure that some US companies will do well with overseas investments. I don't know which ones. GM is investing in China maybe it will eventually become a US owned Chinese manfacturer :wink:
Have fun.

Ataloss
wanderer
*** Veteran
Posts: 363
Joined: Tue Nov 26, 2002 9:33 am
Location: anytown, usa

Post by wanderer »

- Wealthy savvy investors are likely rebalancing and buying stocks as a bear progresses, so that is one source of buyers, I think.

according to the us gov't, we're wealthy (definitely NOT savvy). We have been buying generally more as we get closer to the bottom (fingers crossed). We already had a fair amount of pessimism incorporated into our port, so much of the ride has not been terribly unpleasant.

wanderer
regards,

wanderer

The field has eyes / the wood has ears / I will see / be silent and hear
wanderer
*** Veteran
Posts: 363
Joined: Tue Nov 26, 2002 9:33 am
Location: anytown, usa

Post by wanderer »

I can't "day trade" with my account, but I can periodically switch money from one fund to another. Mine lets me do this up to four times per quarter. If I were still employed and contributing new money, I could also change my investment direction.

can you roll over to vanguard IRA? we did this with both our TSAs (former teachers) and the lower fees and greater repoting flexibility and transparency were a welcome change.

wanderer
regards,

wanderer

The field has eyes / the wood has ears / I will see / be silent and hear
wanderer
*** Veteran
Posts: 363
Joined: Tue Nov 26, 2002 9:33 am
Location: anytown, usa

Post by wanderer »

I believe this behavior is performance chasing no different than those who jumped into equities for the first time in 2000 and 2001, or those who moved from equity fund to equity fund AFTER each fund had a run-up.

I agree. It is very hard to be right - it is lonely. One of the comforts is that there is almost always something with a decent valuation and diversification means the hangover is less taxing.

My concern is that bonds and equities are currently richly priced, leaving only cash as a viable investment option. But, as my friend wanderer reminds all of us, cash is an asset class.

:wink: hard won learnings that.

That's also why we are hearing so much discussion of real estate on this board. But my personal feeling is that we have already experienced a sharp run-up in real estate prices as well, at least in my neck of the woods. And I personally have no interest in non-local direct real estate investment outside of my VGSIX. How wanderer has the courage to do this I'll never understand. Of course, courage is the first rule in successful investment strategies.

i think this is along the lines of my first comment. you just wanna be in there before many people catch on. the thing about real estate is that it's like wallpaper, you don't really notice it. but a simple review of contacts, the limited general data, etc. show that this thing will flow with the economy plus provide a bit of ballast, tax breaks, cash mgmt opportunities, etc.

Some think our approach is insanity and i'm not sure they're not right. but no total blow ups... yet.

So I take comfort in trying to move as best I can against the herd. Unfortunately, the herd is mulling around with a confused look on its face at present

W&L, the fact that you can see the herd is a very good sign. buy the stuff that looks relatively cheap on a historical basis. no guarantees but it usually softens the bite. and don't be afraid to double down after the port craters a bit. again, softer bite and lower average share cost (closer to present lower values) which is psychologically warming.

wanderer
regards,

wanderer

The field has eyes / the wood has ears / I will see / be silent and hear
wanderer
*** Veteran
Posts: 363
Joined: Tue Nov 26, 2002 9:33 am
Location: anytown, usa

Post by wanderer »

There is some good dough to be made this year without a lot of risk or getting into metals.Gold is starting to remind me of 1999 tech.It may have a lot of upside left but when it falls it falls fast.
Easterm Europe could possibly be big as the governments stabilize
and more business come open to investment.

the gold run up was a good lesson in diversification. wish i'd seen that coming. but like ray says, these opportunities ccome along every year. 1996-2000 was an opportunity to diversify (real estate/intl - big hiccup in 1998 [we bought right thru veiex at $6.00/sh])/clean up our balance sheet (mostly pay off mortgage in 2000-2001).

we have been eyeing china for years. this year has proven to be a great year to be there and we have had a small position.

my understanding is that russia is doing much better (which may not be saying much).

go where the realtive value is, have some inflation protection, husband your cash (ie preserve your options)...

i think :wink:

wanderer
regards,

wanderer

The field has eyes / the wood has ears / I will see / be silent and hear
wanderer
*** Veteran
Posts: 363
Joined: Tue Nov 26, 2002 9:33 am
Location: anytown, usa

Post by wanderer »

I do not think that this is necessarily true...at least, not to the extent anticipated. My guess (remember...as long as I don't have a clue, I can say anything) is that many retirees will try to live on dividends alone without selling stocks and they will be successful. We have seen more and more people favor such an approach, both on this board and elsewhere. Many will want to pass their stock holdings to their heirs and to their favorite charities...in spite of what the bumper stickers say.

hocus (and i and a lot of others especially here) get this. the investor is flesh and blood and perhaps the primary flaw in the traditional approach is its overreliance on a frequently dyspeptic mr. market.

among the 50 or so people (friends, colleagues, students) who regularly ask for my highly warped financial perspective, i find that the truly rational are not making make or break bets. they are highly conditioned to NOT spending the principal. So they have pensions, and bonds and real estate and so on.

Maybe they're stupid. Maybe it's human nature. dunno. All I know is that a couple gs a month of interest helps me feel nearly impervious to the market's gyrations. Me? I'm definitely stupid.

wanderer
regards,

wanderer

The field has eyes / the wood has ears / I will see / be silent and hear
wanderer
*** Veteran
Posts: 363
Joined: Tue Nov 26, 2002 9:33 am
Location: anytown, usa

Post by wanderer »

oh, as to who will buy/future trends - i would say some combination of what bubble has postulated/linked to will come to pass: deflation of asset prices, destruction of the currency. plus we'll have some new demand from the 120mm new folks coming to the US/being born to mostly immigrant families in the next 45 years.

the US holds one high ground, although this one is seemingly in prepetual jeopardy: it is the best expression of/experiment in a free market economy the world has ever seen. most of the world hates so many things about us. on one thing they are virtually united in admiration: the opportunity free markets offer for a person willing to work and push and move up.

if the us can maintain that pre-eminence, this will be the premier place to place investment funds and there will never be a shortage of buyers. mess with that and we will have major trouble unloading our shares. and if the alternatives become more attractive (ie what china is making faltering steps toward) that could be trouble, too. But the multinationals should be so intertwined by that point that that should soften some of the impact.

anyway, random thoughts...

wanderer
regards,

wanderer

The field has eyes / the wood has ears / I will see / be silent and hear
Post Reply