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Ben Stein How Not to Ruin Your Life

Ben Stein, How Not to Ruin Your Life

How Speculators Exploit Market Fears

by Ben Stein

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Excellent (2084 Ratings)
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Posted on Thursday, August 2, 2007, 12:00AM

Here's a fact: The speculators and hedge fund managers who run today's stock market need market volatility in order to make money.

They can't make enough money if the market stays flat or moves only a bit, so they like extreme and unexpected price movements. They especially like sudden, surprise movements down, when they can make money off stocks they borrow and sell -- or, as they say, "sell short."

Money Lust Satisfied

That's what's been happening the past couple of weeks. But it's not interesting to say that the speculators are whipping the market around to satisfy their money lust. So the speculators themselves make up reasons for why the market is fluctuating, flog those reasons to the media, and then profit if some other speculators believe the jive reasons and jump in the way the manipulators want them to.

Supposedly, the market is "correcting" because of worries about the housing slowdown, and also because of fears that the debt markets that support mergers and acquisitions is drying up.

These are interesting theories, and people who don't know a lot about the stock market or the economy might find them beguiling. What follows are a few truths that show how shallow these "reasons" for the stock market moves are.

Housing a Theory

Yes, the housing market has slowed from a spectacular bubble level to a simply pretty good level. Housing sales and starts are now about what they were in 2002, and no one thought we were in a housing depression then.

In any event, housing is only about 5 percent of the economy. If it falls by 15 percent, that would represent a fall-off of about .75 percent. That's not trivial, but it's also not the stuff of which recessions are made.

The fact is that there is no recession. The economy is suffering from a labor shortage, not a surplus of unemployment. The Fed is worried about excess demand, not slack demand.

Corporate profits set new records every day. Whatever's happening in residential sales and building is simply not slowing down the economy. Why should a Boeing or a Merck or a Pfizer have any reaction to housing at all? Because the speculators sell everything they can when nervousness sets in -- and for no other reason.

A Minor Major Mess

Subprime is a mess. But it's a small mess. Subprime mortgages account for roughly 20 percent of mortgages even in the most heavily exposed states. About 20 percent of them are delinquent in some way. That's 4 percent of mortgages.

Of these, maybe half, or 2 percent, will go into foreclosure. There will be roughly 50 percent recovery on sale of these. This is a loss of 1 percent in the mortgage market -- a sum the lenders have already made many times over because of the hefty fees on those deals. In the context of the size of the U.S. financial sector, it's nothing.

And why should a crisis in subprime drive down stocks in Mexico and Thailand? Again, because the speculators seek to create panic to make money by selling short, and they sell short everything.

There's simply no connection between subprime and developed or developing nations' stocks. This by itself shows the thin context of the selling wave late last month.

Money's Still Cheap

What about the supposed drying up of loans for mergers and acquisitions by private equity firms? Well, here's a good, simple test of just how valid that explanation is for stock market moves: The majority of private equity takeovers are financed with junk debt.

If there really were a major shortage of funds for these deals, the interest rate on the junk would skyrocket. Instead, while the rate has risen by about 150 basis points in the past month, the spread between junk and investment grade is now about 290 basis points, according to leading junk analyst Martin Fridson.

This is a lot lower than the year-end average of the spread from 2002 to 2006, and far below the almost 800 basis point spread during a true interest-rate crunch like the one after the tech meltdown in 2000-2002.

So that's phony, too. Interest rates have risen, but not anything like what they've done in real crises. And besides, the Dow fell by about 550 points the week before last, yet not one of the Dow stocks is involved as either acquiror or acquiree in a private equity deal.

In short, money is no longer virtually free the way it was for private equity deals in the past year. But it's not expensive by historical standards, either.

Spreading the Fear

In other words, it's all the speculators trying to panic us so their sell programs will make money. And they'll make money as long as they can spread their panic. When they can't do that any longer, they'll work the long side -- and make up reasons for that, too.

In the meantime, the economy is strong. Profits are great, and interest rates are low and will stay that way. Don't sell. With all the shrieking about the market, it only fell to what it was about five weeks ago -- and we didn't think we were poor then.

So let the speculators shout "fire." As of right now, they're not blowing anything but smoke.

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322 Comments

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  • Don - Wednesday, October 31, 2007, 12:23PM ET  Report Abuse

    • Overall: 4/5

    Great to have someone who is not spreading rumors and fear.

  • GD - Wednesday, October 31, 2007, 10:53AM ET  Report Abuse

    • Overall: 5/5

    Fortunately, although I am not an expert, I did not sell by thinking with similar logic. Affirmation in these matters is always a comforting thing.

  • Horatius - Monday, October 29, 2007, 5:23PM ET  Report Abuse

    • Overall: 5/5

    2 months after this article demonstrated that the author was fine. Don't trust in Wall Street's opinion and profit the panic!!

  • Yahoo! Finance User - Friday, September 28, 2007, 11:03AM ET  Report Abuse

    • Overall: 5/5

    Great Article, like many readers thought, I do not believe this article is about putting blame on short sellers. I think this article is great at providing a different mentality for going into investing as a whole. Sure if you borrow on margins and options, then this article is not relevant to you and you should not be critisizing it because it does not match your investing goal, for people like me who are investing for the long term, this article is a perfect example of why we do what we do.

  • Yahoo! Finance User - Wednesday, September 19, 2007, 7:01PM ET  Report Abuse

    • Overall: 2/5

    Pretty funny that I figure a lot of the people giving 5 stars are actually sarcastic, or they truly believe that speculators and hedge fund managers get together with the media and forcing a sell-off. Yeah, we should take all these people to the back of the barne and shoot them. So what happened to all those good Wall Street people and good investors?

  • michaelE - Tuesday, September 18, 2007, 1:14AM ET  Report Abuse

    • Overall: 1/5

    1. It's not just subprime, alt A is in trouble too. 2. It's a vicous circle, prices drop because of subprime forclosure overbuilding and this drives down prices, more people have a hard time selling there house for what they have in it. 3. More people are having a hard time getting financing to buy houses so there are fewer buyers. 4. Even the adjustable rate home owners who don't go into forclosure will see a large rise in their monthly payments thus they will have less $ to spend on other things 5. People won't be able to take out home equity loans to finance their spending. This guy has no concept of what's going on. He think s a few speculators can drive the market like this. I guess there are no speculators driving the market when it is rising????

  • Yahoo! Finance User - Monday, September 10, 2007, 4:10PM ET  Report Abuse

    • Overall: 2/5

    I am a fan of Ben. All his articles have been enlighting. When I read this article I had my doubts. I bookmarked it and wanted to notice the things he said about the effects of housing market. I guess, you know the results now? It is way more than .75 percent and so big that our leaders had to interfere.

  • gene - Sunday, September 9, 2007, 8:51PM ET  Report Abuse

    • Overall: 5/5

    Ben Stein is a master. What's most obvious is his uncommon common sense. How refreshing.

  • CJ - Tuesday, September 4, 2007, 1:16PM ET  Report Abuse

    • Overall: 4/5

    Very good strategic advice

  • Ray - Friday, August 31, 2007, 9:44PM ET  Report Abuse

    • Overall: 5/5

    Great article

  • joseph - Thursday, August 30, 2007, 4:51PM ET  Report Abuse

    • Overall: 4/5

    passed this on to those idiots who report "the facts" on cnbc. i can't wait for fox to launch their market program....thank you

  • Brian - Tuesday, August 21, 2007, 12:47AM ET  Report Abuse

    • Overall: 5/5

    I learned more in this article than I have about the stock market in the last 6 months. Sincerely, Brian

  • Matt - Monday, August 20, 2007, 2:49PM ET  Report Abuse

    • Overall: 3/5

    Good points, but as you should know fundamentals aren't everything. Perception is everything and doesn't always reflect fundamentals. People standing for almost two hours in line to withdraw their savings from banks is reason for concern. Part of our economy is entering into what could be a snake eating its tail type of situation where the reaction to the hype intensifies the problem.

  • fred - Friday, August 17, 2007, 12:36PM ET  Report Abuse

    • Overall: 4/5

    The COT data (commitment of traders) seems to support Ben's explanation, with large speculators being massively short going into the August options expiry. Perhaps a a follow up could be done with some supporting numbers regarding these short positions?

  • Joe - Thursday, August 16, 2007, 1:20PM ET  Report Abuse

    • Overall: 5/5

    Super article. Buy the good stocks as their prices decline - don't just hold.

  • SoccerFinance - Thursday, August 16, 2007, 11:52AM ET  Report Abuse

    • Overall: 1/5

    Ben, if you had good sense you'd be begging Yahoo! to remove this article. The modicum of truth in this article is overwhelmed by the total lack of relevance to the current market. The day you published this article was not your best day. Call the Fed and ask them about the smoke, maybe they will be kind enough to show you the fire.

  • Yahoo! Finance User - Thursday, August 16, 2007, 11:26AM ET  Report Abuse

    • Overall: 5/5

    Thanks, Ben, for the balanced perspective - and the facts that support it. Just reading that housing accounts for only 5% of the overall domestic economy made me realize that the past couple of week's market events are being distorted.

  • Chi - Thursday, August 16, 2007, 9:25AM ET  Report Abuse

    • Overall: 5/5

    Very good article but reality has been different in last 2 weeks.

  • mike - Tuesday, August 14, 2007, 11:58PM ET  Report Abuse

    • Overall: 1/5

    This article is simplistic, irresponsible, and plain idiotic. This market selloff has nothing to do with shorts and everything to do with massive deleveraging by a myriad of financial institutions who have driven this market up and reaped huge profits over the last couple of years by leveraging themselves 10, 15, 20, and even 25 times equity. Ever buy stock on margin? If your broker allows you 2:1 your losses are doubled but you still have to lose 50% on your position before you're wiped out. Do you wait that long...no, you sell. Now try being 25 times levered. If your positions drop 4% your done. So what do you do? You sell. Alot. As all of these securities flood the market prices drop and the next over-levered company or fund has to de-lever. Meanwhile, no new debt is issued and the spending party that's been undertaken by the government, businesses, and the consumer for the past five years grinds to a halt. This has a dramatic effect on corporate profits not only by directly impacting the top line, but also by decreasing margins as competition heats up when companies make every effort to do more business to keep their bottom line growing. Before we hit a bottom in this market there will be earnings revisions to the downside, layoffs, and an expansion of credit spreads beyond the five year average, which Ben so astutely pointed out is still more favorable than the five year average. But what do I know? According to Ben I'm just an unsophisticated investor. An unsophisticated investor who started selling in late May in increments all the way through the top and is now sitting pretty compared to the sad sacks that are doing nothing and waiting for Ben to give them more reassuring bulls$&t fluff to make them feel better as their portfolio gets hammered. Keep betting on Ben. If he was horse he would be glue by now.

  • Adrian - Tuesday, August 14, 2007, 2:35PM ET  Report Abuse

    • Overall: 5/5

    One year ago in May everyone was saying the market would crash completely and those people were wrong and probably lost money for selling. So please sell if you are afraid, it only helps me reap larger profits in the long run. Let the fear overrun your mind while my focus and higher sense lets me exploit your weakness.

  • Yahoo! Finance User - Tuesday, August 14, 2007, 11:03AM ET  Report Abuse

    • Overall: 5/5

    Good Article. When the relentless TV ads for sub-prime loans, ARM's, interest only loans and mortgage refinance disappear, then, I will believe there is a crisis.

  • The - Monday, August 13, 2007, 6:34AM ET  Report Abuse

    • Overall: 3/5

    Man, I agree that Ben is a bit of a light weight when it comes to dispensing investing advice, but some of you commenters are a bunch of complainers! Subprime is still relativley small and you'll notice that most sentences in the press which descibe what horrors might happen to other areas of the economy all begin with the word "if". And that's a big f*&%in if. Don't belive the hype. We should all be looking at this turbulent time to selectively buy quality on the big dips. Who cares what Marc Faber has to say? He puts a nice textbook example together of why the U.S. market should fall 30%, but I've heard his song before in the 1980s and 1990s, only sung by different performers. Somehow the markets managed to climb higher. Why is now suddenly the time when they won't?

  • Yahoo! Finance User - Monday, August 13, 2007, 12:54AM ET  Report Abuse

    • Overall: 1/5

    Too bad Yahoo doesn't have an editor sharp enough to critique Ben Stein's moronic columns. He calls the subprim mess "small/" Central banks worldwide just injected several hundred billion dollars of liquidity for this "small" mishap; astute investors like Jim Rogers (whose investing success is on the public record--unlike the success, if any, of Ben Stein) and Marc Faber term it a watershed event. Plainly, it will have a massive impact. As for speculators always shorting stocks, nonsense. They do like some activity, but this sort of wild volatility is not what any speculator is looking for --witness the hedge fund returns this month. Count on Stein for conventional drivel ("buy a custom suit", etc)--he has a racket that Yahoo protects by not forcing him to reveal his positions and past results. My guess is that any index would whip him,

  • Cyril - Monday, August 13, 2007, 12:19AM ET  Report Abuse

    • Overall: 1/5

    Ben: I love your focus but as usual, I'd love to see which side of the market you're on. Something tells me you may have an axe to grind. The economy cannot be judged by what your partner in crime Bernaeke says...something tells me you're batting on the same team. Get out of the high rent district and take a shuttle to the middle class....first housing...next the real bomb..credit cards. Wait until the credit card crisis starts getting air time!!

  • Yahoo! Finance User - Sunday, August 12, 2007, 10:42PM ET  Report Abuse

    • Overall: 3/5

    "Housing sales and starts are now about what they were in 2002, and no one thought we were in a housing depression then." 'This is your captain speaking... we've lost an entire wing and have plummeted to 3000 ft. There is absolutely no need to worry... shortly after takeoff we were at 3000 ft and no one was worried. Why would you worry now?'

  • D - Sunday, August 12, 2007, 8:39PM ET  Report Abuse

    • Overall: 2/5

    This is inaccurate. News writers make up reasons for the price action of the market. Most speculators and hedge fund managers have conviction over their reasons to buy and sell, but it’s the good ones that know it’s supply and demand that drives markets. Fear and greed are mere echoes of the reality of this.

  • LukeG - Sunday, August 12, 2007, 8:37PM ET  Report Abuse

    • Overall: 1/5

    It is never a good sign when people start blaming short sellers. Where are the buyers to squeeze the shorts out if holding some of these victim stocks (which is how you make them out to be) represent such great investment opportunities? You and your overly zealous buddy larry kudlow should stop filling the small investor with mislead hope based on your unsophiscated analysis.

  • thehun - Sunday, August 12, 2007, 8:21PM ET  Report Abuse

    • Overall: 1/5

    Ben Stein is a shill for the big Wall St firms. It makes you wonder how much he personally has at risk in the markets. I heard the same crap from Ben and company back in 99-2000 when the markets where just starting to crack and look what the end result was. Yeah bubble mania is alive and well on Wall BS St this time it involves many more asset classes. Fed infusing more money into the system will only make things worse in the long run!

  • BELIZIDIA - Sunday, August 12, 2007, 8:20PM ET  Report Abuse

    • Overall: 5/5

    This very lucid article confirms every bit of research conducted through the statistical evidence of delinquencies, foreclosures etc..etc.. Add the very fact that the figures are heavily skewed by six or seven states in the whole country!

  • FYI - Sunday, August 12, 2007, 5:54PM ET  Report Abuse

    • Overall: 5/5

    as always Ben is correct, fear mongers out to get the little uninformed guy. Ben you will be rewarded in heaven for your deeds here on earth, Keep up the great works. remember people wall st will be using oil now as their gas pedal as we come out the other side of this phony malaise, so don't be tricked into becoming an oil co bagholder.

Showing comments 6-35 of 322<< PreviousNext >>
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