Stock Market Suckers, by Vox Day

Suckers! Many conservatives are aquiver with excitement that George Delano is daring to brave the third rail of American politics, the much-beloved welfare program set up by his philosophical predecessor, FDR. It is true, of course, that Social Security is nothing but a government-run Ponzi scheme, that there is no trust fund, that as an investment it is a complete rip-off, that it rewards white women at the expense of black men and that it is an outrageous violation of the Constitution of the United States of America.

But this does not mean that the Bush administration’s plan to allow a modicum of private investment in the stock market is necessarily a winner or even an expansion of individual freedom in America. A single column is not sufficient to address a subject this complex, so I shall simply focus on one erroneous argument that is often used to support the administration’s plan, namely, the notion that stock prices inevitably move up over time.

Superficially, this appears to be a most persuasive argument. If one looks back to 1965, which is when 65-year-olds retiring now were first entering the job market en masse, the Dow was around 900. Last Friday, the Dow closed at 10,800, a 12x gain. There can be little question that no Social Security recipient is getting back $12 for every dollar he put into the system, and yet, we must consider the first of several flaws in this crude analysis, namely, inflation.

Of that $12, almost half was nothing but inflation. One 1965 dollar is worth $5.81 now. That phenomenal gain doesn’t looks so great now, given that one could do better than half as well just collecting compound interest, even at the miserable interest rates offered in basic savings accounts. But that’s not all – it gets much worse.

One of the many dirty little secrets of Wall Street is that the Dow of 1965 is not the Dow of today. In fact, the Dow of 1995 is not the Dow of today, nor is that of 2003, for that matter. This is due to “rebalancing,” which is a reconstitution of the index to get rid of companies that are underperforming or disappearing altogether. It is vital to understand this, because no investments are made in indices and relatively few are made in index-matching funds. Most investments are made in the stocks of individual companies and, due to this “rebalancing,” the return on the dogs and the bankrupted dead are not reflected in these historical comparisons. Since 1999, seven corporations representing almost one-quarter of the Dow have been dropped and replaced.

The situation is significantly worse with regard to the NASDAQ-100 (NDX), which flip-flops more often than John Kerry running for office. Last year alone, eight companies were kicked out of the showcase technology index – Cephalon, Compuware, First Health Group, Gentex, Henry Schein, NVIDIA, Patterson-UTI Energy and Ryanair. Some of these corporations had been added only recently, and it is even possible for companies to bounce in and out of the NDX as their stock price alternately soars and sinks. For example, Synopsys and Symantec both rejoined the index in 2001 after being previously dropped.

In the last four years, there have been 44 changes to the 100 companies making up the NDX – 1999 was a banner year for such beauty-enhancing alterations, as the addition of 30 new companies helped drive the index to its all-time high of 4,816.35 on March 24, 2000. Despite the rebound year of 2003, and the aforementioned attempts to pretty up the index, the NDX is still down 68 percent since that 2000 high.

And if you’d been unfortunate enough to invest in some of those 30 corporations added in 1999, you’d have done even worse. You’d likely have nothing at all. Global Crossing (GX) was one of those high-flying newcomers – it was dropped by December of the following year and an attempt to see how it’s doing on today an online financial site will reveal the following result: “Symbol(s) do not exist: GX.”

Yes, and neither does your retirement fund …

A legitimate historical analysis of any index must account for all of this rebalancing turnover. Unfortunately, the market masters do not make this easy. The NASDAQ even claims not to keep track of this information – it’s much more interested in explaining how it is the stock market for the next 100 years, even if its annual rate of 11 percent turnover means it will have fewer original pieces left to it than Cher in a decade, let alone a century.

The ancient Roman saying caveat emptor is applicable to every proposed transaction, but never more so than with regard to the stock markets, where history is rewritten on an annual basis. The Bush administration’s plan features a number of questionable assumptions, but its biggest flaw is that its logic is based on a foundation of historical fiction.

About the Author: Vox Day is a novelist and Christian libertarian. Visit his web log, Vox Popoli, for daily commentary and responses to reader e-mail.