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August 2017

Latest Market Madness Shows That Our ‘Gambling Addiction’ Runs Deep

In this newsletter, I’ll compare investing in the stock market to gambling on sports through websites like FanDuel. I believe that what has happened in the markets recently not only supports that premise but is symbolic of the fact that we, as a nation, have a gambling addiction.

As you probably know, last month, the Federal Reserve reset short-term interest rates again for the second time in 2017, raising their benchmark rate to a range of 1–1.25 percent. The move was expected and supposedly represents a show of faith that the U.S. economy is moving in the right direction. In a statement, Fed Chairman Janet Yellen cited modest job growth and the fact that economic activity has been “rising moderately so far this year” as key motivators.1

That’s hardly compelling data. The fact is, GDP growth actually fell in the first quarter compared to the fourth quarter of 2016, and inflation is still lagging behind the Fed’s stated goal of 2 percent.2 More importantly, long-term interest rates have not moved in accordance with the Fed’s confidence or with the apparent optimism shown by Wall Street since Donald Trump’s election. Although the stock market has hit new record highs multiple times since November, the bond market has mostly been flat. The 10-Year Treasury rate did rise from 1.8 to 2.6 in the month following the election, but it hasn’t gone higher since. In fact, it has not topped 2.5 since mid-March.3

Gambling with the Yield Curve

That’s significant because it means the Fed has been pushing ahead with its commitment to raise rates despite not only a low inflation rate but also the risk of flattening the yield curve. As I’ve explained before, the yield curve is based on the differential between long-term rates and short-term interest rates. Banks need long-term rates to rise ahead of short-term rates in order to make lending worth their while. A flat yield curve can create a disincentive for lenders, which can cripple economic growth.

In other words, the Fed is basically betting on the idea that long-term rates are going to start rising, in much the same way that big investors—who’ve driven the stock market up 15 percent since November—are betting that Trump is going to make good on his promise of 4 percent annual GDP growth. They’re betting that he’s going to be able to pass his ambitious tax plan, health care plan, and budget—all of which have many critics, even within the Republican party.

As we’ve seen time and again in this new era of artificial economics, ever since the financial crisis, our government and Wall Street have been gambling on the idea that appearances will spawn reality—that illusion can fix fundamentals. But, in the end, it is gambling because they’re betting on a certain outcome with no control over whether it occurs. The Fed can’t force long-term rates to rise or inflation to increase, and even Wall Street’s biggest investors have no real power to push Trump’s tax plan through Congress. They’re merely crossing their fingers and toes in hopes that these things occur and their bets pay off.

All of this is indicative of the way many Americans have been educated—or, more accurately, mis-educated—about investing over the past 30 years or so. Ever since 401(k)s replaced most traditional pension plans, many people have been taught that the stock market is an investment strategy in which they have a fair amount of control.

Investing vs. Gambling

I believe that’s wrong. When Warren Buffett invests in a company, he’s generally buying a controlling share: a seat on the board, in other words, which gives him a level of control over that company’s fate and a say in whether it succeeds or fails. The average investor, on the other hand, has no such say and no such control. Investors are usually putting money into a company in the mere hope that it succeeds; thus, compared to Warren Buffett, they’re not investing, they’re gambling.

It’s an even bigger gamble if that everyday investor is putting money into mutual funds because in that case, the investor is not only betting that the company’s managers will do a good job, they’re betting that the fund manager will do a good job picking the right companies. The further removed you are from decisions made about your money, the more you’re gambling instead of investing.

That’s why I want to use FanDuel as an analogy for explaining the difference. As a sports fan, if I were to go on FanDuel and place a bet on the New England Patriots to win on Sunday, my goals would be aligned with those of Robert Kraft, the team’s owner—because if the Patriots win, we both make money. But that’s where the comparison ends. I have no control over the team, and Robert Kraft does. He’s hired the coaches and the players, and he may even have a say in strategy. He’s investing, but I’m gambling, pure and simple, in the same way that—compared to Warren Buffett—I’m gambling when I play the stock market.

By contrast, if I should invest in my own business or in a house I plan to renovate or in any financial strategy that involves contracts and assurances on behalf of the investee—those are legitimate investments. In those cases, I have transparency and a certain degree of control.

With a fixed-income strategy, for example, I may not have control over whether the total value of my investment rises or falls from month to month based on fluctuations in the market, but I have a contract with an insurance company assuring me that it will generate the same level of income regardless.4 In my opinion, that’s a true investment compared to the gamble I take as a minority-interest stockholder.

And, even though the government and Wall Street have yet to break their gambling addiction, in my experience, investors at or near retirement age are breaking the habit!

  1. Lauren Gensler, “Fed Raises Interest Rates for Second Time in 2017,” Forbes, last modified June 14, 2017, https://www.forbes.com/sites/laurengensler/2017/06/14/fed-raises-rates-june/#683bdb516987
  2. www.usnflationcalculator.com
  3. Ycharts.com
  4. All guarantees are based on the financial strength and claims-paying ability of the issuing insurance company.

* Investment Advisory Services offered through Sound Income Strategies, LLC, an SEC Registered Investment Advisory Firm. Wright Financial Group, LLC and Sound Income Strategies are not associated entities.

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MONTHLY NOTE

 

“Difficult roads often lead to beautiful destinations” –Anonymous.

From everyone here at Wright Financial Group, LLC, we hope you are enjoying the summertime and remember to appreciate the journey!

MARKETING NOTE

 

“Our Age of Anxiety is, in great part, the result of trying to do today’s jobs with yesterday’s tools and yesterday’s concepts.” – Marshall McLuhan

For advisors, some anxiety might stem from attracting new prospects, but this doesn’t have to be your struggle. A good marketing approach could be the difference between attracting new business and chasing it.

Call your Primary Coach to see how our latest marketing tools and concepts can help you attract new clients and overcome today’s challenges.

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