Your Questions About What Is Wrong With The Stock Market

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Chris asks…

Is the recent stock market climb due to Bush and his dilligent economic policies?

The stock market has been going up due to Bushs policies. Remember when Democrats say “Obamas only been in office for 5 weeks?”

Well according to their logic thats not enough time to do anything wrong, therefore whatever Bush did in his final days was right, and we are seeing the end to Clintons recession finally.

Its just too bad Obama is trying to take credit for it, fact.

Justin answers:

The joke of the day. Way to go.*

Michael asks…

What type of probability distribution does the stock market follow?

I am trying to figure this one out…it’s not normal distribution since all values should gravitate around the mean..which is not the case in the stock market(and related markets). I tried to approximate as well the CDF of Levy distribution…and I might be doing something wrong – but I am getting infinity there…
One thing is clear though: the probability is continuous.

thanks…

Justin answers:

The statistical models which I know use a lognormal distribution centered around forward price of the stock, i.e. The price of the stock inflated by the “risk-free” interest rate.

David asks…

What type of probability distribution does the stock market follow?

I am trying to figure this one out…it’s not normal distribution since all values should gravitate around the mean..which is not the case in the stock market(and related markets). I tried to approximate as well the CDF of Levy distribution…and I might be doing something wrong – but I am getting infinity there…
One thing is clear though: the probability is continuous.

thanks…

Justin answers:

Sorry but your question does not really make sense.
Maybe you could detail it further.

Charles asks…

What were the causes of the great depression?

What was wrong with the stock market during the 1930s and why did it crash? Why did that lead to the great depression? Why didn’t Hoover try to fix things? How were the people affected by the depression?

Justin answers:

From what i understand it happened as a result of the new “buy now, pay later” method

James asks…

Is the stock market a good indicator of how the economy is doing?

I hear from many people that if the stock market is doing well that that necessarily means the economy is doing well overall. But with the recent increase in oil prices, stagnant wages, the mortgage/credit crisis, and a government with a lot of unfunded liabilities, I find this kind of hard to believe. Can anyone give some objective info on this question?

Justin answers:

Its a matter of definition…in their mind a good economy = stock market is doing well and their investments doing well. (someone who places a lot of weight on the stock market or the entire weight is a selfish elitist type person who has no idea nor really cares what happens to other people)

mine would to take the pulse of a country by looking at a broad array of indicators from unemployment rate, to inflation, housing market, bankruptcy filings, job growth, real salary decline/increase, netflow of jobs, illegal labor impact, budget deficits, trade deficits, energy prices, etc……

YOu have to look at the big picture….but actually if you ask americans in poll, they will usually give you a good idea of where the country is at…and such a poll right now would show that 70% of americans believe the country is headed in the wrong direction, and I would say that at least 60% of the respondents would say the economy is not doing good.

Mark asks…

How does Obama’s highly likely 2nd term win negatively affect the stock market?

I’ve heard a lot of talk saying if Obama wins the election in November the stock market will go into correction mode yet again. I’ve heard this a lot on CNBC. How would Obama’s victory make the stocks fall?

Justin answers:

It won’t and really anybody who says that isn’t thinking very well;

1) Anytime anybody says “[blah] is highly likely and it will cause the market to fall” they are wrong. If [blah] is bad for the market and it is highly likely than the market has already accounted for that and iscounted itself by whatever probability represents “highly likely” * amount that it is bad for the market. That’s pretty much fundamental to efficient markets.

2) Pretty much because of 1), electons have very limited effect on markets. Their outcome is usually known before they happen and the impact of who is president is pretty much unknowable. Most market pundits would probably like Romney to be President as he would likely be really amenable to lowering capital gains taxes, taxing dividends as capital gains, allowing his buddies to keep money in Grand Cayman and not pay taxes on it, etc. So this whole line of dialogue is about stumping for Romney.

Edit: “I have no idea what an Obama win may bring to the market. Neither does anyone else.” Nonsense (at least the second sentence). A Romney win would be much better for the stock market in all likelihood. The guy is a Wall Streeter through and through. The probability of a Romney win is already priced into the market.

Thomas asks…

Why is the stock market so important?

I know the basic idea of the stock market, but I’m in high school and I haven’t taken Economics yet, so I don’t know why the stock market is so important to our economy. Would someone mind explaining?

Justin answers:

First of all, you should rephrase your question. The stock market isn’t important to the economy, it’s the economy that’s important to the estock market. It really it a shame that high schools don’t teach finance or economics at a younger age (my high school is no different, I learned from reading, reading, and more reading).

The stock market is really only important to the people who invest in it. When people say they invest, they mean that they’ve either:

1. Purchased shares of a company (usually traded publicly or OTC)

2. Purchased bonds

3. Have money in a mutual fund or money market fund

4. Invest in real estate

To people who don’t invest in any of the above, this currrent economic crisis means little or nothing to them.

The way the stock market works is that the short term fluctuations of the market are based ENTIRELY on people’s expectations for the future, and CANNOT BE PREDICTED BY EVEN THE BEST OF EXPERTS. If you ever see someone saying that they know what will happen in a few days, weeks, or months, they don’t know for certain! They might even be dead wrong (which happens all the time).

Basically, in a good economy (low interest rates, more consumer spending) people by more things; whether it’s a new house, car, TV or stocks. You’ll notice that in the past good economies have resulted in the stock market being considered “great” and a “safe place to invest your money in”. When the economy slows down (as it is doing now), there’s less consumer spending, and thus people invest less or take more money out of the stock market to pay for their discretionary and non-discretionary expenses.

But don’t get me wrong, the stock market and economy ALWAYS fluctuate (they always have good times and bad times). Right now, we’re in one of the bad times, but in time the economy will speed up and the stock market will recover to it’s former “glory”.

Ken asks…

Does anyone think the stock market could just drop 4,000 points in a single day?

I just have a feeling the stock market is going to TANK 4,000 points or more one day. And gold is going to rise to 1:1 the stock market.

Justin answers:

In the stock market, extreme situations occur far more frequently than a gaussian normal distribution would suggest, this is called the fat tail effect. In general, you protect yourself from uncertainty by money management, in other words don’t bet the farm.

For example, if you could wager as often as you’d like on a fair 50/50 coin toss with favourable 2 to 1 payout odds (you win twice your wager and receive your wager back when you win, lose your wager when you loose), how much of your total wealth should you wager with each coin toss? The odds are favourable and the expected value would be that you would receive $1.50 for every $1.00 wagered in the long run but if you wagered everything you own with each coin toss, you stand to lose everything with the first loss, if you wager nothing then you don’t benefit from the opportunity at all. The optimal is somewheres between not investing and investing as much as possible when the return is uncertain. That’s why they say to proportion your portfolio between stocks and cash equivalents such as high quality bonds, it’s to account for the possibility that the market will drop, should the market actually drop, the proportion of the portfolio value that’s in stock will drop so you would rebalance by buying more stocks till you’re back at your target proportions. With the aforementioned coin toss, the optimal amount to wager is 25% of your networth and being a simple win lose scenario, it can be easily calculated by the Kelly equation but multiple and concurrent outcomes are best calculated by optimizing for the geometric mean outcome which in the case of the coin toss would be varying the wager till the following equation is at a maximum:

e^( “probability of a win” * ln( “Your total wealth if you win” ) + “probability of a loss” * ln( “your total wealth if you lose” ) )

If you try it, you’ll see that the geometric mean of the outcomes for the coin toss is at a maximum when the wager is 25% of your total wealth as predicted by the Kelly equation.

If you use general reasonable probabilities for stock investment such as 2% chance of total loss (based on the average life span of a Fortune 500 company being 40 years), 10% chance of a 60% loss (based on every decade seeming to have at least one major downturn) and a 15% return when things are going well; the geometric mean outcome would be at a maximum if you risk 50% of your net worth. If it is a diversified index fund that you are investing in, the risk of total loss is pretty much diversified away and if you only consider the 10% chance of a market downturn in a given year, you get the optimal at 83% of your funds to risk. It’s interesting to note that Ben Graham in his book “The Intelligent Investor” says that based on experience he would recommend close to a 50/50 proportioning and to go no lower than 25% and no higher than 80% at risk. Claude Shannon once derived the 50/50 portfolio rebalancing approach during one of his many tangents while giving engineering lectures and proved mathematically that the 50% proportion is the optimal in an efficient market where all factors have been priced in leaving only a random walk.

A lot of people are saying that they have a feeling that the market is going to tank, but it’s always going to tank some day. So what are you going to do about it? Stay out of the market? Mathematically there are two wrong answers so long as there is some uncertainty, to stay out of the market and to be 100% invested in the market yet those are the two options people always go for.

Are you going to buy gold? What’s the value of gold? Does gold produce anything? Does it grow and compound itself? With gold it’s value is retained when kept in registered vaults so there is a storage cost, if you hold it yourself on unregistered premises, there is a larger spread due to the risk of having to re-assay the gold. Gold is only better than money in that money’s authenticity and value is provided for by a government which enforces it’s value by decree (fiat money) and enforces prohibitions against counterfeiting. Gold is accepted by all governments because it’s innate physical property of density provides a means of authenticating it effectively, gold is over twice as dense as lead so in ancient times, it was impossible to hollow out a gold object and fill it with a lesser valued material without substantially changing it’s weight hence he difficulty of counterfeiting gold isn’t limited to the active enforcement policy of a single country as it is with money. Physical properties are not limited by political borders and hence the advantage of gold over cash but really do you think the US is going to disappear overnight?

Richard asks…

When Will the Stock Market Begin Recovering?

When will the stock market bottom out and begin an overall recovery? When would be a good time to start buying stocks again for maximum returns?

Justin answers:

Ah, if only anyone could accurately predict the future. The S&P is down about 40% from it’s peak right now. The stock market has had many large one year declines in its history, probably one or two years or so in every decade. Historically, now would be a great time to start buying because large declines are often followed by equally large gains. Everyone is fearful right now and they stay fearful and out of the market until the stock market starts rapidly increasing. By that time, they have already missed a lot of the upside.

Having said that, we do face a somewhat unique situation. Could the stock market go lower? Yes. How much lower? NOBODY knows. It is easy to find countless examples of “experts” who have been dead wrong in stock market predictions. As for me, I am now going into buying mode. I am incrementally buying stock mutual funds with money that I will not need for a least 5 years. Historically, the stock market being down 40% is a tremendous time to buy. The only difference would be if this was another Depression. But the goverment is taking aggressive steps to prevent this. And even if it does happen, find comfort in the fact that we are all screwed for a few years.

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