Why the Stock Market Matters - practical business checklist, Q1 2022

Turn on any news channel, or pick up any newspaper, and some form of stock market news will present itself, with its mysterious ticker symbols colored in red or green, or another talking head yammering endlessly in obscure terms. For most of Main Street America, Wall Street is another world, inhabited by people in suits who never get their hands dirty, and wouldn’t know the difference between a shovel and a hammer if they were hit over the head by one. Many who make an honest living with their hands think that other world either has no bearing whatsoever on their lives; or they think of those men in suits as the “higher ups” who are pulling on the strings of power for their own gain at the expense of the working man. Neither of these views are accurate, and becoming less so every day.

Here’s why.

Everyone now has a vested interest in the stock market. For many years in the U.S., the common man had a few simple options for saving or investing his hard-earned capital. He could have stuffed it in a sock. If inflation was low, the only risk associated was someone else finding the sock. He could have put it in a CD. This was a good, safe option, and sometimes yielded surprisingly well. This was an almost zero risk way to invest, but had the down side of being illiquid. He could have loaned it out privately. This potentially gave him more return than putting his capital in a certificate account, with the added benefit of being more liquid, but also carried more risk.

Of course, there were always as many options as there was imagination, but most options beyond the above three were not explored by the common man for several reasons. They were either too capital intensive, too complicated to navigate, or too risky. Stock market investing tended to have all three barriers to entry and so were usually the realm of sophisticated investors. The net effect was that, for many years, what happened on Wall Street had an indirect effect on the average man. The most observable effect was unemployment levels. When Wall Street suffered, the major employers in the country by extension were less likely to be hiring, which led to higher unemployment. The most extreme example being the 1929 stock market crash. Nowadays, with so many social safety nets in place, even that effect is less noticeable in every day life. Does that mean the stock market has less to do with the average man than ever before? On the contrary.

What were the norms in the ‘80’s and 90’s, have steadily changed in the 2000’s. There are several factors- including monetary policy, interest rate suppression, Robinhood, and retirement funds.

Ever since the housing bubble in the early 2000’s, both Congress and the Federal Reserve have consistently signaled their eagerness to underwrite banks and major corporations when they get into trouble. This monetary policy has been taken advantage of at a massive scale, and corporate debt now stands North of 11 trillion dollars, compared to just over 4 trillion as we began the millennium. (federalreserve.gov) This has also led to unprecedented stock valuations, and blurred the line between investment grade and junk bonds.

In addition to writing off bad debt, the Fed has also suppressed interest rates to incredibly low levels in the last 20 years, also contributing to both corporate debt levels and stock valuations. From a historic perspective this means that a lion’s share of the investments made during that era are risky. At the same time, suppressed interest rates took bank certificate investing off the table.

Founded almost a decade ago, Robinhood was a completely new approach to investing, aimed at the masses. It not only allowed users to invest thru an easy-to-use app, but also bypassed brokerages and associated fees entirely. It was massively successful, and spawned an entire retail investment industry. Even legacy brokerages like Fidelity and Vanguard started offering retail products aimed at a new generation of investors. This phenomenon has created an almost Ponzi style scenario for stock indices, where new money flowing in is driving up prices regardless of the underlying fundamental values of the companies themselves. In every day speak, it would be comparable to owning a small business, such as a blueberry patch - and putting your own wages into it every year to keep it going. The equity line looks fine in spite of a consistent loss on the P&L, which is not a great way to run either a blueberry patch or a Fortune 500 company.

With government policy consistently holding interest rates low over many years, managers of retirement funds gradually shifted their mix of investments away from safe havens like bonds to riskier assets like stocks. This has further contributed to the inflated values on Wall Street, while increasing the individual’s exposure to the stock market.

These changes mean three things for the man on Main Street.

First, government policy and stock market fluctuations, whether up or down, are set to have a more direct impact on small businesses than ever before.

Secondly, we’re due for a major stock market correction. In general, publicly traded companies, by almost any metric, are hugely overbought and overindebted. To maintain margins, those men in suits are taking risks unheard of just a few years ago. In part they can justify it by government guarantees of the risks, but no one really knows how far out on that limb you can sit.

Thirdly, between the Employment factor, the Robinhood Factor, and the Retirement Factor, there are far more people directly exposed to stock market corrections than any time in history. Before you congratulate yourself on being one of the lucky few who has no money tied up in Robinhood or an IRA, you need to ponder a term common in the world of suits. It’s called “counterparty risk” and refers to the risk associated with being even second or third hand associated with a risk. For example, if your son is on your insurance policy, and buys a hot motorcycle, your insurance rates will go up whether or not you ever intend to ride that thing yourself. You are at counterparty risk with your son and his driving habits. Similarly, the entire U.S. economy is at counterparty risk to the stock market. There is bound to be a correction at the very least, and many people will be surprised by how directly it affects them.

To illustrate this, a respected financial analyst, Stephanie Pomboy recently quoted a statistic that “a 25% correction in the stock market is currently comparable to 80% of U.S. annual GDP.” (Gross Domestic Product). This means that if the stock market were to correct just 25%, which is not at all unheard of historically, it would be a financial loss equivalent to 80% of all the money spent in the U.S. for a whole year. That’s a staggering number when you realize many of your customers are likely exposed to the stock market. It also explains why the Federal Reserve is so sensitive to stock market corrections.

Another direct effect for employers is the employment factor. When a society chooses to remain at home on government benefits rather than returning to productive employment, the results are very negative long term. Without going into the whole picture, we at the least know how hard it has become to hire quality help in recent times. If a stock market correction occurs, driving unemployment up, it could actually help Main Street with better access to the labor force, but only if people choose to work!

We can’t know when the balloon will burst of course, or exactly how it will deflate, but our feeling is that we are probably pretty close. What to do about it? We are encouraging our clients to position their businesses defensively in the near term. Obviously, there is no way to eliminate counterparty risk, but there are a few things we would consider prudent from a business standpoint.

1. Manage your debt load. It’s not just corporations who have found it easier and cheaper to borrow money in the last two decades. Farmers, contractors, and most everyone else on Main Street have had the same lending environment - and have become accustomed to debt levels that would make our grandfathers green around the gills. That’s because they remember 1929.

2. Build a reputation for service. When work slows down as it’s bound to do some time, a reputation for going the second mile might make the difference.

3. We think now is a good time to get out of luxury services. If you own a cute Airbnb on a creek somewhere, sell it or turn it into a regular long term rental, and focus on a necessities oriented business model. Of course, if you can afford to wait out a down turn that advice may not apply to you, it’s a matter of balancing your risks.

4. Keep your books clean! Now more than ever it’s going to matter whether you know what’s going on with your business’s numbers. If you’re not sure what your numbers mean, schedule a consultation, and we’d be happy to help you understand your numbers in context.

5. Pray about it. No one knows the future, anyone who confidently predicts it is just guessing and bluffing. But the Lord knows, and we firmly believe He can direct our path in the right way thru an uncertain future.

In conclusion, we encourage you to step forward in faith with your business, but don’t ignore the context of government policy or stock market action. It all connects to you and your business.