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How Does the Stock Market Work?

The stock market is the only place where anyone can invest in human ingenuity. It is a bet on the future being better than today. Stocks can be thought of as a way to ride the coattails of intelligent people and businesses as they continue to innovate and grow. Short of owning your own business, buying shares in the stock market is the simplest way to own a slice of the business world. The greatest part about owning shares in the stock market is you can earn money by doing nothing more than holding onto them. When companies pay out dividends to shareholders, you get cold hard cash sent to your brokerage or retirement account which you can choose to either reinvest or spend as you please. The stock market is one of the few places on earth where you can earn passive income without having to do any work whatsoever. All you have to do is buy and wait. And if global stock markets don’t go up over the long term you’ll have bigger problems on your hands than your 401(k) balance. Many people compare the stock market to a casino but in a casino the odds are stacked against you. The longer you play in a casino, the greater the odds you’ll walk away a loser because the house wins based on pure probability. It’s just the opposite in the stock market. The longer your time horizon, historically, the better your odds are at seeing positive outcomes. Now these positive outcomes don’t guarantee a specific rate of return, even over longer time frames. If the stock market were consistent in the returns it spits out, there would be no risk. If there were no risk, there would be no wonderful long term returns. And because there is risk involved when owning stocks, your returns can vary widely depending on when you invest in the stock market. It has been possible to lose money over decade-long periods in the past. Even 20 to 30 year results can see a big spread between the best and worst outcomes. However, it is worth noting that even the worst annual returns over 30 years in the history of the U.S. stock market would have produced a total return of more than 850%. This is the beauty of compounding. The worst 30 year return for the S&P 500 gave you more than 8x your initial investment. The stock market is a compounding machine in other ways as well. Since 1950, the largest companies in the U.S. stock market have seen dividends paid out per share grow from roughly $1 to $60 by 2020. Profits have grown from $2 a share to $100 a share. Those are growth rates of roughly 6000% and 5000%, respectively, over the past 70 years or so, good enough for 6% annual growth for each. One dollar invested in the U.S. stock market in 1950 would be worth more than $2,000 by the end of 2020. $10,000 dollars invested in the S&P 500 in the year: We’re ignoring the effects of fees, taxes, trading costs, etc. here but the point remains that over the long haul, the stock market is unrivaled when it comes to growing money. And the longer you’re in it the better your chances of compounding. Having said all of that, there is an unfortunate side-effect of this long term compounding machine. Stocks can rip your heart out over the short term. If there is an ironclad rule in the world of investing, it’s that risk and reward are always and forever attached at the hip. You can’t expect to earn outsized gains if you don’t expose yourself to the possibility of outsized losses. The reason that stocks earn higher returns than bonds or cash over time is because there will be periods of excruciating losses. That $1 invested in 1950 would grow to $17 by the end of 1972 and subsequently drop to $10 by the fall of 1974. From there it would grow to $95 by the fall of 1987, only to drop to $62 over the course of a single week because of the Black Monday crash. That $62 would have turned into an unbelievable $604 by the spring of 2000. By the fall of 2002 that $604 would have been down to just $340. After slowly working its way all the way to $708 by the fall of 2007, over the next year-and-a-half it would be cut in half down to $347 by March 2009. By the end of December 2009 that initial $1 was worth $537, which is less than the $590 it was worth a decade earlier by the end of 1999. So $1 growing into $2,000 sounds amazing until you realize the many fluctuations it took to get there. The stock market goes up a lot over the long term because sometimes it can go down by a lot over the short term. The stock market is fueled by differences in opinions, goals, time horizons and personalities over the short term and fundamentals over the long term. At times this means stocks overshoot to the upside and go higher than fundamentals would dictate. Other times stocks overshoot to the downside and go lower than fundamentals would dictate. The biggest reason for this is because people can lose their minds when they come together as a group. As long as markets are made up of human decisions it will always be like this. Think about how crazy fans can get when their team wins, loses or gets screwed over by the refs. These same emotions are at work when money is involved. How you feel about investing in the stock market should have more to do with your place in the investor’s lifecycle than your feelings about volatility. Disclaimer: Investing in financial markets carries risk, including loss of principal. You can lose some or all of the money that is invested. Past performance is no guarantee of future results. The material contained herein is

Weird(er) Markets – GameStop Edition

We’ve never seen anything like this GameStop story. It’s taken on a life of its own and when this many people are paying attention to something there is bound to be misinformation and misunderstandings. So we wanted to look at what we feel are some of the biggest overreactions to this story: This has nothing to do with the efficient market hypothesis. The massive gains in January for GameStop (around 1,600% at last check) have nothing to do with markets being efficient or not. Markets aren’t completely efficient and they never have been. But no one really knows what GameStop is truly worth and people who claim to know what it should be priced at are just guessing. Burton Malkiel in his classic book A Random Walk Down Wall Street has my favorite take on this: What efficient markets are associated with which is wrong is that efficient markets mean that the price is always right – that the price is exactly the present value of all of the dividends and the earnings that are going to come in the future and the price is perfectly right. That’s wrong. The price is never right. In fact, prices are always wrong. What’s right is that nobody knows for sure whether they’re too high or too low. It’s not that the prices are always right, it’s that it’s never clear that they are wrong. The market is very, very difficult to beat. Markets will never be fully efficient because humans are the ones who make a market. But they’re still hard to beat. Just ask Melvin Capital. This doesn’t disprove the idea that markets are more or less efficient as much as it shows how random they can be in the short-term. Every long-term investor implicitly assumes markets are kind-of efficient otherwise what’s the point of investing? Robinhood shutting down trades was not some grand conspiracy. It makes for a good story that Robinhood was in cahoots with the hedge funds. And the morning they announced the ban of trading in certain stocks did feel fishy. Alas, the true story is far less nefarious than some people believe. This is a combination of highly volatile stocks interfering with the internal plumbing of the way trades settle and a company that simply grew too quickly and was undercapitalized for this type of situation. Robinhood has been taking on customers at a rapid pace. They’ve experienced problems numerous times throughout the past year. They became synonymous with getting people to trade and it came back to bite them. Even Alanis Morissette would find it ironic how the company that pushed people to overtrade is now seeing its brand tarnished from people overtrading. But that doesn’t mean Robinhood was working with the Illuminati on this one. The company just wasn’t ready for primetime when it came to explaining what happened and why. Leadership at the firm could use some help with crisis management. Short sellers are not all evil. Personally, we are not wired to be a short-sellers because we are more of a glass-is-half-full kind of group. But short-sellers can serve a purpose in the markets. Short-sellers can help keep out of control corporate management in check. They can also help discover fraud, as was the case with companies like Enron and Lehman Brothers. And they pay interest on the shares they borrow which reduces fees on things like index funds and ETFs through short lending. This instance was more a case of hedge fund investors who took risks they shouldn’t have. Hedge funds were the dumb money and they got called on it. But this doesn’t mean we should ban all short-sellers. Do some short-sellers try to push down the price of certain stocks? Of course, just like certain long-only investors try to talk up the stocks they own. Also, short-sellers have gotten destroyed ever since the 2008 crash. It’s not like these people have been crushing it. The stock market generally goes up over time so this is a strategy with negative expected returns. Hedge funds did not get bailed out in 2008. Some people are claiming hedge funds are just getting bailed out again. This is not true. Plenty of hedge funds failed in 2008 and every year since. In fact, hedge funds as a group have performed terribly since the 2008 crisis. But I do understand why people lump the hedge funds in with the banks. “Wall Street” is a catch-all term used to describe a group of people who seem to have built-in advantages. Right or wrong, hedge funds and the “suits” are being used as a lightning rod and we completely get it. People are still angry about how the 2008 crisis played out and what has transpired ever since. Trust in the system is faltering. This GameStop ordeal was like a coiled spring for the anger and resentment that has been building from the growing wealth inequality in this country. The biggest mistake our government made following the 2008 crisis was not putting any of those crooked bankers in jail. Instead, the banks got bailouts and many of the executives that caused the crisis walked away will hundreds of millions of dollars in bonuses for their troubles. One of our biggest worries from this situation is more people will lose faith in the stock market and financial system. Markets can be crazy and feel unfair in the short-run. But the best way to beat the system and the hedge funds is not to avoid the markets but to use them to your advantage by thinking and acting for the long-run. No matter what happens with GameStop from here, that will never change. We’ll have more to say on this in the coming days because I’m already hearing from people who now think the deck is stacked against them when it comes to investing. In the meantime, please keep the faith Our article may include predictions, estimates or other information that might be considered forward-looking. While these

2021-Markets Could Get Weird(er)

These are the two scenarios you’re going to hear about in the financial media in the coming days and weeks now that the Democrats have control of the White House, House and Senate:Scenario #1. The democrats are going to crash the markets with higher taxes. Buckle up. Scenario #2. The democrats are going to crank up the dial on fiscal policy in the coming years. That’s going to juice economic growth and inflation. Buckle up. Taking the politics out of the equation, these scenarios are probably more important to markets and the economy in the coming years:Scenario #1. Monetary policy continues to dominate. Scenario #2. Fiscal policy dominates. We tend think that scenario two is more likely.  The fragile 50/50 split in the senate is shaping up to be fiscal goldilocks.  Enough to get stimulus through but not enough to raise taxes. The Fed has kept interest rates on the floor for years in part because the government never stepped up following the Great Financial Crisis by implementing enough fiscal policy. So we the recovery was tepid, job growth was slow and many households had a difficult time following the biggest economic crash since the Great Depression. The pandemic has likely changed all that. We’ve already seen an immense amount of government spending in 2020 and it looks like that will continue into 2021 and beyond. Now that voters have seen what the government can do we don’t see how you can put the genie back in the bottle. Because of a Dem-controlled government and the sheer amount of money spent in 2020, this scenario is now a higher probability than it’s been in years: Higher GDP growth Higher inflation Higher interest rates we don’t know for sure if this will happen but the prospects are much higher than they were coming out of the last crisis. Here’s the problem for those who think the current cornucopia of easy monetary and easy fiscal policy can last forever — they can’t coexist in perpetuity. Something has to give. Let’s say we’re in a situation where we get a huge fiscal stimulus package that sees us through the end of the pandemic. And let’s further assume after the pandemic American consumers consume their faces off on things they’ve been putting off — trips to Disney, dining out, traveling, Taylor Swift concerts, movies, live shows, etc. Assuming the pandemic opened the door to increased government spending and we see a situation with more stimulus checks, maybe an infrastructure bill, some aid to states and municipalities that amounts to trillions of dollars of spending, we could be looking at a situation in 2021 or 2022 where things get weird economically speaking. Things will get weird because higher economic growth from increased government spending should logically lead to higher inflation and thus, higher interest rates (at least beyond the short-term rate set by the Fed). Don’t get me wrong — we think this is a good thing. Millions of people still need help. Interest rates are still low. We have the fiscal capacity for this. But there are sure to be consequences involved when it comes to the markets if things play out like this. Some questions that come to mind if this transpires: Will tech stocks finally underperform in an environment that favors value stocks? Will large cap stocks finally underperform in an environment that favors small cap stocks? Will U.S. stocks finally underperform in an environment that favors foreign stocks? Will investors care if we get inflation if it comes from an improved economy? The last question is the big mystery because it’s been so long since we’ve had rising prices on a sustained basis. In the glorious economic decade of the 1990s, inflation averaged more than 3%. That’s much higher than the current trailing 12-month rate of 1.2% or the average rate in the 2010s of 1.8%. The difference is the 1990s saw inflation fall over the decade. In 1990, inflation was  5.2%. By 1999 it was down to 2.7%. Will investors care more about inflation if it goes from 1.2% to 2.7% rather than 5.2% to 2.7%? This is an arbitrary number but you get the point. The stock market may care about rising inflation more than the level of inflation itself.   Historically, the stock market prefers disinflation to rising inflation. And that could play out this time around as well but caveats abound. We’ve never had interest rates this low before. Government spending is contained not just by inflation but more broadly by political will. Nothing says the new administration will be able to follow through with all of their spending plans. And the stock market could always completely ignore an increase in the inflation rate for the time being if it’s happening because of an improvement in the economy. Regardless of the inflation question, the stock market appears to be pricing in more government spending based on the returns from recent months. Remember election uncertainty? Everyone was predicting higher volatility going into the election because of the contentious nature of politics these days. And there has been volatility — it’s just been to the upside. Everything has performed well since the election but small, value, and international are finally outperforming large and tech. As much as we like to understand the potential reasons for the relative moves within markets and assets classes, most of the time you can simply look at mean reversion. This is probably one of the most underreported reasons for value stocks underperforming growth stocks over the past decade or so. Take a look at the differences in returns between value stocks (Russell 1000 Value) and growth stocks (S&P 500, Nasdaq 100, Russell 1000 Growth) from 2000-2010 and 2011-2020:     Maybe the simplest explanation for the underperformance of value stocks this cycle is the fact that they outperformed during the prior cycle. And look at the returns this century — they’re basically identical. Could a Biden presidency and a Dem majority be the key to a new

December Newsletter

What happened: What we did: What we are watching: Our article may include predictions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this publication. Proxy Financial is a registered investment adviser. Proxy and its Financial Advisors are not licensed in all states to offer securities and insurance products. This site is not a solicitation of interest in any of these products or service in any state which the registered representative is not properly licensed.

November Newsletter

What happened: What we did: What we are watching: Our article may include predictions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this publication. Proxy Financial is a registered investment adviser. Proxy and its Financial Advisors are not licensed in all states to offer securities and insurance products. This site is not a solicitation of interest in any of these products or service in any state which the registered representative is not properly licensed.

Somethings Never Change

This is the craziest market we’ve ever seen. And we don’t say that to be cute or funny. As experienced financial professionals – we mean it. The pandemic somehow turned a bunch of people into day traders. At first, they were buying beaten-down airline and cruise stocks. Now they’ve moved on to buying shares of companies that have filed for bankruptcy. Hertz, JC Penney, Pier 1, Chesapeake Energy and GNC have all filed for bankruptcy recently but have seen massive price swings over the past week: Granted, these stocks are all in death spirals over the past year: This makes more sense but it also makes sense that it doesn’t take much of a rise in price to see a massive percentage gain in a stock like Hertz. The car rental company has gone from a high of well over $100/share to a low of $0.55/share. The past 5 days alone have seen daily price swings in Hertz of -25%, -24%, +115%, +71 and +84%. According to Bloomberg, nearly 100,000 investors on the Robinhood brokerage platform have instituted a position in Hertz over the past week alone. There’s been plenty of finger-wagging and head-shaking going on from professional money managers about the increased activity from the likes of Robinhood traders during this market surge. It’s easy to “tsk, tsk” these types of speculative moves in the markets but this type of behavior is nothing new. This year is unlike anything we’ve ever seen before in terms of market and economic dynamics but there is plenty of investor behavior that has been around since the Dawn of the Markets. Here are some things that will never change about the markets: Lottery ticket stocks will always find a buyer. Our brains are wired such that expecting to make money feels even better than the act of making money itself. It’s the anticipation that puts your brain on high alert. This is why investors and gamblers alike are rarely satisfied with a single win. Your brain always needs another shot of dopamine to get that high again. It’s not enough for speculators to simply accept the market’s return during a massive recovery from a bear market. This is why we’ve seen a move from sector ETFs to beaten-down companies to bankrupt companies. And the temptation to speculate increases when we watch others around us getting rich. People with no skill or knowledge about the markets can still make money. Some of the smartest, most sophisticated investors on the planet have been caught off guard by the market surge in recent months. Not only have these titans of the investment industry watched as the market has passed them by, but the biggest beneficiaries of the rise seem to be tiny retail traders. The market doesn’t discriminate between professional and amateur and there’s no IQ test required to buy a share of stock. The market cashes checks from anyone who plays, regardless of where they have an account or how much capital they have at stake. This is not to say this will continue indefinitely but to paraphrase Keynes, “The market can keep the irrational investor solvent, as long as you remain bearish.” The “dumb” retail money will occasionally beat the “smart” professional money. Legendary investors like Druckenmiller, Tepper and Buffett have all admitted to being positioned too defensively during this rally. This doesn’t make these legends idiots just like it doesn’t make Robinhood investors geniuses. This is just the way things work sometimes. No one bats a thousand. No one is right all the time. Renaissance Technologies, likely the greatest hedge fund machine ever created, has claimed to be right on just 51% of their trades. No one is going to nail every top and bottom, especially in a market environment like this where things are happening at ludicrous speed. Cycles tend to feel like they will never end. When stocks were getting thrashed on a regular basis in March it felt like the selling pressure would never let up. Lately, it’s felt as if stock gains happen every day. Markets are always and forever will be cyclical and no trend lasts forever. Hindsight capital remains undefeated. It’s easy to look back at what’s transpired this year and come up with perfectly logical reasons for the market’s manic behavior. And there are plenty of logical reasons for a market crash that immediately turned into a roaring bull market in the span of 3-4 months. But there are no counterfactuals. Things didn’t have to happen this way. Markets have shown this year how they can be equal parts resilient and fragile. Markets would be a whole lot easier if hard work always translated into better results, if intelligence always guaranteed alpha, if fundamentals always carried the day and if the markets always made sense. Unfortunately, that’s not the case. In the short run, sometimes markets just don’t make sense and you have to stay disciplined and stick to your overarching financial plan. We know – that sounds pretty much like the advice of a financial advisor – but the reality is that there’s not much we can control in an environment like this. But you can control your plan. Our article may include predictions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this publication. Proxy Financial is a registered investment adviser. Proxy and its Financial Advisors are not licensed in all states to offer securities and insurance products. This site is not a solicitation of interest in any of these products or service in any state which the registered representative is not properly licensed.

Investing In Yesterday’s Reality

Some ideas are fleeting and go in one AirPod and out the other. Others just seem to stick for some reason and you’re constantly coming back to them over and over. Paul Graham wrote such an idea in 2014 about how to be an expert in a changing world and it’s stuck with me ever since: If the world were static, we could have monotonically increasing confidence in our beliefs. The more (and more varied) experience a belief survived, the less likely it would be false. Most people implicitly believe something like this about their opinions. And they’re justified in doing so with opinions about things that don’t change much, like human nature. But you can’t trust your opinions in the same way about things that change, which could include practically everything else. When experts are wrong, it’s often because they’re experts on an earlier version of the world. The world of finance is littered with people who are experts on an earlier version of the world. They rely exclusively on specific backtests, formulas and strategies that would have worked wonderfully in the past. Now, I’m not saying we can’t use history to help guide our actions in the markets but so many investors get stuck in the mindset of fighting the last war that they fail to realize things have changed to such a degree that the old playbook needs to be thrown out the window. There are a handful of investment principles that are evergreen but the market structure is constantly in a state of flux. Companies, the market environment, sectors and the macroeconomy are never static so investing like they are can be problematic. A handful of fund managers were lauded for calling the financial crisis of 2008 but they all but missed the subsequent recovery and bull market because they became fixated on a crisis mindset. In fact, the star fund manager is either extinct since 2008 or in deep hibernation. One of the reasons this is the case is because so many professional investors were using a pre-2008 playbook. They assumed the Fed was going to cause massive inflation or a bubble from low interest rates.Interest rates had never been so low for so long and investors were adhering to strategies that worked in the 1980s or 1990s but weren’t useful anymore. We could be setting up for a similar paradigm shift following the events of 2020. In the future it’s possible we look back at the pandemic as a turning point in the use of government spending as a tool to counteract economic contractions. This year we may have experienced the birth of a new fiscal policy regime.  Politicians on both sides of the aisle are increasingly coming to realize that fiscal policy is the “cheat code” of economics. If you’re willing to tolerate inflation risk, you can use it to achieve any nominal outcome that you want. As people become more aware of this fact, they’re going to increasingly challenge traditional approaches, demanding that fiscal policy be used to safeguard expansions and eliminate downturns. Upside-down markets will then become the norm. One of the most confusing aspects of the 2020 market environment to many investors is how such an awful economic backdrop could lead to such strong equity markets. Here is a simple illustration that hopefully will help explain:   The basic idea here is with enough fiscal and monetary firepower, even the worst of economic environments can actually lead to higher prices in financial assets because investors know corporations have a backstop. And that’s exactly what’s transpired this year.The government and the Fed stopped a depression by throwing gobs of money at it and investors looked across the valley because they knew it would be short-lived.This strategy does come with its risks, inflation being the biggest one:    Inflation is not something we’ve had to worry about for some time now, so the downside risks from this new world could be significant. Risk is funny like that. Take one off the table and another magically appears. No one can be sure if 2020 was a fiscal fork in the road. It depends on what the political will for this type of spending will look like. I can’t imagine politicians who wouldn’t pull these levers in the future after witnessing their power but I’ve given up trying to figure out why politicians don’t use more common sense so you never know. Understanding this potential shift doesn’t make it any easier to predict the future because investor reactions to market dynamics are not static either. However, I do know for certain that if you’re an expert on an earlier version of the world, you will likely continue to struggle in this ever-changing investment landscape. We all need to be open-minded in the coming years. Our article may include predictions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this publication.Proxy Financial is a registered investment adviser. Proxy and its Financial Advisors are not licensed in all states to offer securities and insurance products. This site is not a solicitation of interest in any of these products or service in any state which the registered representative is not properly licensed.

October Newsletter

What happened: ·         October saw continued volatility in the equity markets. The month leading up to the US Presidential elections looked as if global indexes might recover from September and approach previous All time highs, but retreated ending the month mostly flat. This mid month retread in the equity market can most simply be explained by the uncertainty surrounding the election as well as COVID-19 cases continuing to raise. All this also lead US fund flows to move out of equities towards the safety of bonds.   ·         Even with Septembers sell off and October remaining mostly flat, Tech is still having a remarkable 2020, with the NASDAQ up over 22% YTD.  However, there is a different story to be told for the DOW Industrial Index and US small cap Companies, represented by the Russell 2000 index, both down nearly 6% at the end of October. This continues to show a stark picture between the economy at-large, compared to “big tech” and which sectors were hurt by the pandemic.  What we did: ·         Proxy managed equity-oriented clients, by holding steady in our allocation over the month with no changes to our Core Equity model.  We maintained  our model exospore to US equities utilizing IVV and QQQ, but have also kept some fixed income exposure via BND.  The algorithm predicted little change through out the month and was spot on.  ·         The Proxy Core Growth model held up well in the recently volatility, which offered the opportunity to add a few new positions.  The strategy, while still heavy in high growth tech, did largely benefit from a few select names in the healthcare and consumer cycle sectors. What we are watching: ·         The US elections seems to be the sole focus both domestically and globally.  With this very heated election coming to an end as the polls close November 6th,  we wait to see if Dem. Joe Biden can hold his lead in the polls or in President Trump we remain on for another 4 years.  With such a close race and President Trump already vocalizing concerns over voter fraud via mail in ballets, there is a chance this may drag on for months to come.  Such a situation could be have a significant drag on economic recovery and the release of addition COVID relief funds. ·         We continue to closely monitor advances in COVID-19 vaccinations, as the winter months approach and cases continue to raise. ·         We remain poised to react quickly if the market does in fact correct again, while remaining consistent with our algorithmic approach in our Core models. Our article may include predictions, estimates or other information that might be considered forward-looking. While these forward-looking statements represent our current judgment on what the future holds, they are subject to risks and uncertainties that could cause actual results to differ materially. You are cautioned not to place undue reliance on these forward-looking statements, which reflect our opinions only as of the date of this publication.Proxy Financial is a registered investment adviser. Proxy and its Financial Advisors are not licensed in all states to offer securities and insurance products. This site is not a solicitation of interest in any of these products or service in any state which the registered representative is not properly licensed.