Political rhetoric can be dangerous to your wealth and security. Like many of you, I have been listening to bits and pieces of the Republican National Convention. Most of it I dismiss as so much political grandstanding and posturing, without real substance. I expect the Democratic National Convention will produce much of the same "bovine scatology."
However, last night the presidential candidate made a statement to which you should pay attention. Understand, if he gets elected and is actually able to get Congress to go along with his plan, it could prove disastrous to your wealth. What he was talking about was his plan to immediately privatize 20 percent of the social security system. That means one out of every $5 being paid into the social security system currently would be immediately diverted to self directed individual retirement accounts. That would be approximately $1 trillion; i.e., 1 with 12 zeros following). That means we, the people, could immediately take 20 percent of our new social security contributions and dump them into the stock market. Folks, that would probably be a formula for a financial catastrophe for individual tax payers, social security recipients and the nation as a whole.
If you are wondering why the opportunity to take control of more of my retirement account does not excite me as a professional investor, I shall explain. The problem relates to what normally determines stock valuation. Ideally, the current value of a stock is related to a combination of the current earnings of the company that issues the stock and the "hopes" or "fears" of the investing public regarding the perceived future earnings prospects of the company.
Over the long term, all stock values tend to reflect reasonable expectations of present and future earnings. That means average stock prices will be around 20 times current earnings. However, there are periods of time when either excessive fear or hope moves the prices of stocks above or below reasonable valuations based on actual earnings. We have been living in such time for the last few years where irrational exuberance drove "Dot.com" stock prices into orbit around the sun with price earnings valuations reading 300-to-1 or more. The same "cosmic" Dot.com stocks have crashed and burned recently as sanity returned to the masses of "wishful thinking" Internet investors.
Importantly, there are a few other factors which significantly affect the level of stock prices besides fear and hope, but which also affect the level of fear and hope. One of those factors is how much money people actually have available to throw at the markets. We professionals call that the amount of "liquidity" driving up prices. "Liquidity" in the stock market is also a function of the "money supply." That is strongly influenced by Federal Reserve Board monetary policy. But it is also influenced by the fiscal policy; i.e., tax or send policies of the president and/or congress.
The bottom line about liquidity is the more money we have to bid up the prices of stocks, the more we are likely to bid them up. The consequence is stock prices will increase less because of the intrinsic value based on their fears about needing to build a retirement "nest egg" and suddenly have the extra cash to do just that.
Bush's plan would probably lead to another era of "Irrational Exuberance" inflating equity market prices to stratospheric levels having no rational long term relationship to reasonable valuations based on real current earnings or rational expectations about future earnings. It would also lead to further distortions in our financial markets too great to list and discuss here, not the least of which would be bankrupting the social security system if some international financial crisis led to our own stock market crashing. We all know that has happened more than once in the past. There is no reason to think it will not recur in our lifetime.
I hope Bush's musings about the social security system will prove to be just the usual election "bovine scatology."
Clifton Maclin is an SEC-registered financial services representative in Carson City.