One of nature's cruelest creations is the hurricane -- an eye of tranquillity surrounded by destruction. Just when you think you've survived the worst, the other storm wall hits you in the face.
Investors have faced a similar storm in the financial markets. It's no wonder so many have given up on stocks and focused on gold or bonds instead. With no act of God to blame, we fault Wall Street insiders, who we suspect are working behind the scenes to fleece average Americans out of the hard-earned money in 401k's and individual retirement accounts, creating and then profiting from wild ups and downs.
I don't think the deck is stacked, but I won't kid you: The average investor is playing against pros with more expertise and practice in a market where it's not easy for anyone to make money.
The eye of the storm
Three years ago, Bear Stearns rescued two of its hedge funds that had gone bad after betting heavily on subprime mortgages. That was just the beginning. What followed was a near meltdown of the global financial system, the deepest recession in generations and a stock market decline of more than 50%.Last year, the clouds parted and the sun emerged. Starting in March, investors began buying again; in the rally that followed, stocks regained more than 60% of their losses. The economy started expanding and is now creating jobs. Home prices stabilized. The banking system recovered.
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Many suspected foul play and manipulation in all this. Speculators were attacking the debt of countries like Greece and Portugal in the credit derivatives market. This had the knock-on effect of pushing down European stocks and the euro. This weighed on commodities and stocks in general as the U.S. dollar climbed.
As for the flash crash, it appeared that the automated trading systems that make up an increasing share of total market volume had experienced a glitch. (Read "Wall Street's high-tech war on investors" for more on how these work.) But quantitative trading experts I spoke to, as well as the Securities and Exchange Commission's preliminary report of the event, indicate that structural issues, an increasingly fragmented exchange network and the need for major market players to control risk had turned an ordinary down day into something much worse.
If that sounds like a non-explanation, it is. And it's a perfect summation of where we are right now. To a lot of investors, the stock market doesn't make sense anymore.
Going nowhere fast
Despite all the volatility, the broad market has gone nowhere for the past seven months. That almost seems normal. The market really hasn't gone anywhere since 1999; that's when the Dow first crossed the 10,000 level it's been struggling to hold. After including dividends, using information from Global Financial Data, the Dow has returned just 15.7% since 2000 -- about 1.4% per year.Investors could've done better by plopping their money into bank certificates of deposit. Five-year CDs were yielding 7% back in 2000 and 4% in 2005 -- which would've been worth an average annual return of 5.5% over the period and a total return of 71%. (They're paying a lot less now, so that refuge isn't open.)
On the other hand, it's been a good 10 years for professionals. We've all read about Wall Street bonuses, which even with the financial crisis barely slowed. We've heard executives testify that they see no responsibility to tell you they're betting against an investment they're touting to you, or vice versa.
Just last month, Goldman Sachs (GS, news, msgs) reported its traders had made money on every trading day in the year's first quarter -- even while, as Bloomberg reported, only seven of Goldman's nine recommended trades for investors paid off. They win, we lose, right?
Consider also hedge funds and other shadowy pools of institutional money that operate freely, outside the restraints of regulation that burden pension funds or mutual funds. According to Hedge Fund Research, the average hedge fund gained 86% over the past 10 years, or 6.4% on average per year.
With the pros using hoards of borrowed cash, crack teams of researchers and economists and an army of Ph.D.s programming automated trading algorithms that can fire off buy and sell orders within microseconds, does the average investor have a prayer?
Continued: Pros caught flat-footed, too