Surfing and the Stock Market

Magnificent surf is found where there are large expanses of ocean and strong steady winds. Surfers wait at such places waiting for ideal conditions. Like the surfer eyes the ocean from the shore, investors look for investments on the horizon before they crest so that they can ride them high and triumphant. However the surfer knows the wave will crash on the shore and he will tumble with it. He will laugh shake off the water and start again. The investor, however, believes that with the right strategy he can dance from one wave to another and never return to shore until its time to retire and consume the wealth that has grown. The surf is always up on the stock market, he thinks.

Unfortunately the wave that the investor rides has a height based on the day-to- day supply and demand. It lacks the reality of the Friday night poker game. When a poker game ends everyone cashes out their chips, and to avoid violence the money in the bank has a one-to-one correspondence with the chips on the table. Sneak chips into the game and the discrepancy will be discovered before you will be allowed to go home. A poker game could be like a stock market if the players agreed to keep the game going perpetually with a large number of players. Individual players could cash out or buy in at staggered intervals. In that way the value of each chip could increment according to the “market value” placed on it when a new player enters the game. Poker would then be like the stock market, more open but much more deadly.

During the calendar years from 1999 to 2007 the American Gross Domestic product grew at modest rates from .78% to a high of 4.43%. Over these eight years a production of $100 would have grown to $124.40, just under a total growth of 25%. That figure is rough but it more or less indicates “real growth in productivity.” During the same period, according to the Standard and Poors index, a $100 typical stock-market investment would have grown to $140.27 or just over 40%. An investment in American real estate of $100, according to the Case-Shiller index would have ended up at $200.77 which is just over 100% growth. This is astonishing when compared to the $124.40 in real economic production that is available to support a market gain in housing value.

It should have been apparent several years ago that a bubble was building in the housing market which was in danger of bursting, or a wave was cresting that had to crash. Perhaps one of the reality forces that struck the housing market in 2008 was the impact of boomers cashing in savings to cover the cost of retirement lifestyles.

Income tax regulations in the US and Canada allow for investments in personal residences to be sheltered from capital gains. Pension and retirement savings plans have also sheltered huge sums from taxation, and this money has been in pursuit of profits being regularly reported in the real estate market. The escalating housing markets made it more difficult for entry-level purchases, which would have cut into the profits of banks and mortgage companies. At least in the US the response was to relax the down payment requirements, which continued to escalate the wave of investment.

Our family spent some Christmas time with my wife's aunt, who rents a house in Vancouver, BC with two other couples. Their total rent is $1600 per month. That house could have sold earlier in 2008 at $750,000. From the $19,200 rent the landlord would have paid taxes of $3000 or more, making his return on investment about 2% less maintenance costs. Aunty L is concerned about how grudgingly and sporadically repairs are made to her house. Personally surprised considering the housing investment return that anyone is trying to properly maintain homes in Vancouver. Normal economics should force buyers to purcahse more cheaply, and sellers to do so more readily.

Not only is this situation short-sighted it is economically counter-productive. Instead of encouraging productivity through moving talent to our cities, we are attracting investors who want return without any particular attention to productivity.

There are some painful solutions that should be considered.

• A “real productivity index” should be independently produced to show the growth of stock market companies in terms of increase in goods and services provided as opposed to returns from capitalization or investment growth itself;
• The bulk of pension and retirement savings funds should be required by government to rank high on the "real productivity index" in order to obtain tax sheltering;
  
• The maximum mortgage investment possible on a first mortgage should be in part determined by the ability of the rental market to cover the interest on the mortgage; and
• Tax sheltering of primary residence investment should be phased out in favour of sheltering of investments made in productivity growth.

The "Real Productivity Index" would be based on the degree to which a company translates its available capital into production, and equipment upgrading. It would also depend upon positive cash flow from goods and services provided. It would not reflect growth in the speculative value of its assets. In the long run productivity growth is of a more dependable value, and is more likely to create the new jobs, goods, and services that will assist those planning to withdraw and spend from tax sheltered savings and pension plans.

The last point has some intriguing possibilities. To realize a tax-sheltered income (replacing primary residence sheltering) families should be allowed to create businesses and shelter a large part of the income from taxation. In that way the intelligence and creativity of people would be rewarded instead of the ability to sit in a residence waiting for the investment value to increase. Homes would be bought and sold according to their ability to assist the residents in being productive in their lives.