Is the Stock Market a Positive-Sum Game or a Ponzi Scheme?

[John Creighto]

that is beside the point - you said to use game theory jargon. The sum of the winnings is a positive number, hence its not a zero sum game

This would seem to be a different issue then the topic of the original thread as it only answers if on average people in the stock market benefit. On the whole, the stock market would create wealth to the extent it improves the efficiency of production by properly allocating resources. It would destroy wealth to the extent which it either hinders the allocation of resources (by hoarding assets, diverting liquidity away from smaller players) or adds an extra administrative cost which could be better devoted to other uses.

Given that in economics these days questions are often posed in marginal terms, it might be better instead to ask: if a small change in the wealth traded on the stock market would create more wealth (How would we measure this wealth and who would benefit from it?).

Remember that the stock market is not the only way to allocate capital. People can invest through savings, through profit, they can borrow from banks, they can borrow from friends, they can borrow from the government. The stock market favors large public companies. It is an irrelevant means of acquiring capital for private companies and small companies.

 

[BWV]

yes, but all you would have to show is that with a purely private market for companies the cost of equity capital would be higher

 

[Tosh5457]

that is beside the point - you said to use game theory jargon. The sum of the winnings is a positive number, hence its not a zero sum game

You're ignoring the players who gave the money to those players who won money. That's like analyzing a fixed number of poker players in a table, without accounting for the new players that enter. In that case it can be a positive or negative sum game, since you're not accounting for all the players.

 

[russ_watters]

You're ignoring the players who gave the money to those players who won money. That's like analyzing a fixed number of poker players in a table, without accounting for the new players that enter. In that case it can be a positive or negative sum game, since you're not accounting for all the players.

Count any players you want to count, Tosh, you can't make poker a positive-sum game: the sum of all of the returns is zero. The analogy was your choice. If it doesn't work, it hurts your argument, not ours.

You don't accept the fact that the company growing doesn't give the stockholders any direct benefit.

Incorrect and annoying since we've covered this already. I'm perfectly aware that there is no direct benefit besides the ownership itself. The part you don't understand is that a direct benefit isn't necessary. I've said this many times.

The only benefit they'll have, in average, will be to see their stock rise in price because of others investors expectations rising.

Right, as long as you acknowledge that those expectations aren't completely imaginary. Apple's profit projections for this year and Apple's profit projections for 1982 are a lot different from each other, for good reason.

But a game just made of transactions will always be zero-sum.

Er. Well, if you pay me $100 for a stock only worth $1 I don't think that's a zero-sum transaction. I think you argue against your point by calling this a pyramid scheme, then describing it as zero-sum. Regardless, no, the game is not just made of transactions. In between the transactions, something else happens that adds or removes value from the game.

Transaction 1: Boeing stock is trading for $100 and I buy it at $100.
Event: Boeing is awarded a $1 billion airplane contract. The market recognizes the new earnings potential of Boeing and the perceived value rises to $150.
Transaction 2: I sell my stock for $150.

Transactions 1 and 2 are zero-sum transactions; nobody won, nobody lost. The Event is the actual value of the stock changing between the two buy/sell transactions. So I gained money because the stock gained value because the company grew.

A second scenario regarding dividends:

Transaction 1: I buy a stock currently valued at $100.
Event: The company pays me a dividend of $5/share.
Transaction 2: I sell the stock for $95.

Again, transactions 1 and 2 are each zero-sum transactions. In the Event , my stock lost exactly $5 of value because the company took $5 from its bank account and gave it to me. So the stock instantly became worth $5 less.

Come to think of it, that's kinda how poker works in a casino: the house takes money out of the game.

Anyway, the only way for each transaction to be zero-sum is if there is actual value added to the company (or removed) in between, which is exactly what happens.

Anyway, I still haven't understand something. Russ, are you trying to say the stock-market isn't a zero-sum game in respect to the profits of the stockholders...

This is also annoying because I stated it explicitly in post #5. You're not absorbing anything that's being said, which implies to me you aren't interested in real discussion (much less learning), just arguing one point at a time, regardless of if they repeat. But again:

The stock market overall is positive sum with respect to the profits of the stockholders because the value of what they are trading rises. The value of each transaction is zero sum.

The value of what is being traded has to rise otherwise the transactions aren't zero sum. Let me say that again, another way:

In a pyramid scheme, each transaction is negative sum. That's why they collapse: the value of the pyramid is always negative, so if too many people try to cash-out, it collapses.

For stocks, if you pay $100 for a worthless piece of paper, that's not zero-sum. The piece of paper has to actually be worth $100 for it to be zero sum.

 

[nitsuj]

Transaction 1: Boeing stock is trading for $100 and I buy it at $100.
Event: Boeing is awarded a $1 billion airplane contract. The market recognizes the new earnings potential of Boeing and the perceived value rises to $150.
Transaction 2: I sell my stock for $150.

Transactions 1 and 2 are zero-sum transactions; nobody won, nobody lost. The Event is the actual value of the stock changing between the two buy/sell transactions. So I gained money because the stock gained value because the company grew.

A second scenario regarding dividends:

Transaction 1: I buy a stock currently valued at $100.
Event: The company pays me a dividend of $5/share.
Transaction 2: I sell the stock for $95.

Again, transactions 1 and 2 are each zero-sum transactions. In the Event , my stock lost exactly $5 of value because the company took $5 from its bank account and gave it to me. So the stock instantly became worth $5 less.

Come to think of it, that's kinda how poker works in a casino: the house takes money out of the game.

"So I gained money because the stock gained value because the company grew." by signing a contract? Turns out it cost Boeing two billion to fulfill the contract, what worse is the planes were negligently faulty; effect is they abruptly fall from the sky.

Who could've guessed there were risks to a company signing a contract worth a billion dollars to build one of the most complicated machines this world has that transports the most valuable assets of all. Seems the guy who bought your stock for an inflated 150 thought it was a sure bet. Lucky for them they won't be named in the lawsuits. Not too bad a deal, having no claim to the assets of the company.

 

[nitsuj]

Ugh, I didn't see this before: As I said to Tosh several pages ago, don't let the complexity added by multiple owners confuse you into thinking the definition of "ownership" changes. It doesn't. The stockholders own the company. So "The company owns" is still synonymous with "the stockholders own".

And incidentally, since you were non-specific and you worded it badly, the case you described was for one shareholder: You set up the company and sold the entire company to me, making me the sole owner of the bar of gold. But since I know you meant there are multiple shareholders...it is still wrong. The bylaws may or may not include direct voting on policy. If the voting is direct, all you have to do is convince 50%+1 shareholders to vote with you. If the voting is indirect, you just have to do the same except electing a representative who will do what you want.

The fact that it is cumbersome for stockholders to make major changes in large companies and doesn't happen often does not change the status of stockholders.

In any case, this was already discussed in detail and I have rehashed more than I really wanted to. For fuller treatment, read back a couple of pages.

You own the company, the company owns the gold. Think you have all the decision making power?

Why not just take a loan, secured by the gold bar. bank deposits cash to Corp'. bank account, you as sole owner feel it's your money and deposit it into your personal account and buy a home or whatever. value of gold drops.

Bank is nervous and now calls in the loan, business has no money and you decide to simply have the corporation declare bankruptcy. And you're all free and clear right?

nope, you're going to court for the money you stole. You and the corp are separate entities, oddly you just stole from something you have ownership of. Maybe that's what is confusing you, that corporations are legal entities (which would be odd since historically it's significant).

So no "The company owns" is still synonymous with "the stockholders own" is not even remotely accurate.

 

[enosis_]

You own the company, the company owns the gold. Think you have all the decision making power?

Where was that claim made in the post cited?

 

[Tosh5457]

Russ, I'll just drop the poker analogy, but not because it's a bad analogy, it's because you never understood it since the beginning.

The part you don't understand is that a direct benefit isn't necessary. I've said this many times.

Stockholders need a benefit (i.e. be able to access the wealth of the company in any way) for holding a stock for your position to even have a chance to stand still. If there is no benefit, they're just trading pieces of paper, and that will never be anything else other than a zero-sum game. Whether the expectations of the investors are imaginary or not, independently of the reason of why they're trading, it'll always be a zero-sum game in respect to the profits. And no, more investors coming into the market doesn't change that fact as you argued before, independently of where they got the money (real economy or otherwise). That's by the way the reason I used the poker analogy, because more players coming into a poker game doesn't change its nature.

This is also annoying because I stated it explicitly in post #5. You're not absorbing anything that's being said, which implies to me you aren't interested in real discussion (much less learning), just arguing one point at a time, regardless of if they repeat. But again:

If you have to understand my motivations for arguing, I'm arguing because I think I'm right, or I wouldn't be arguing, and because many stock traders take comfort in the illusion that the stock market is positive-sum game instead of taking comfort in their skill as traders.

 

[enosis_]

Russ, I'll just drop the poker analogy, but not because it's a bad analogy, it's because you never understood it since the beginning.



Stockholders need a benefit (i.e. be able to access the wealth of the company in any way) for holding a stock for your position to even have a chance to stand still. If there is no benefit, they're just trading pieces of paper, and that will never be anything else other than a zero-sum game. Whether the expectations of the investors are imaginary or not, independently of the reason of why they're trading, it'll always be a zero-sum game in respect to the profits. And no, more investors coming into the market doesn't change that fact as you argued before, independently of where they got the money (real economy or otherwise). That's by the way the reason I used the poker analogy, because more players coming into a poker game doesn't change its nature.



If you have to understand my motivations for arguing, I'm arguing because I think I'm right, or I wouldn't be arguing, and because many stock traders take comfort in the illusion that the stock market is positive-sum game instead of taking comfort in their skill as traders.

Are we going to pretend that dividends are possible? If you own a share and a dividend is paid you receive value and retain ownership of your share.

 

[nitsuj]

Where was that claim made in the post cited?

"The company owns" is still synonymous with "the stockholders own"

"You set up the company and sold the entire company to me, making me the sole owner of the bar of gold."

 

[enosis_]

"The company owns" is still synonymous with "the stockholders own"

"You set up the company and sold the entire company to me, making me the sole owner of the bar of gold."

You left out the part I questioned..."Think you have all the decision making power?"

 

[russ_watters]

You own the company, the company owns the gold. Think you have all the decision making power?

As the sole owner of the company, I absolutely do.

Why not just take a loan, secured by the gold bar. bank deposits cash to Corp'. bank account, you as sole owner feel it's your money and deposit it into your personal account and buy a home or whatever.

You're describing a home equity loan except using a bar of gold instead of a house as the equity. Yes, I've done that.

value of gold drops.

No, it doesn't, unless you worded that badly: The value of the bar doesn't change, its just that the ownership (or part of the ownership) of the bar changes hands. The bank gives you $x and they take ownership of $x of the value of the bar. If the value used to be higher, then the remaining equity that you own is now $y-$x. Total value unchanged.

Bank is nervous and now calls in the loan, business has no money and you decide to simply have the corporation declare bankruptcy. And you're all free and clear right?

No, you have to forfeit the bar (or part of the bar) to the bank. That's what an "equity loan" is!

...nope, you're going to court for the money you stole. You and the corp are separate entities, oddly you just stole from something you have ownership of. Maybe that's what is confusing you, that corporations are legal entities (which would be odd since historically it's significant).

I'm not sure if you are calling failure to pay back a loan "stealing". I wouldn't but it doesn't matter either way: yes, the bank takes the bar of gold from you in a court proceeding of foreclosure.

So no "The company owns" is still synonymous with "the stockholders own" is not even remotely accurate.

Having demonstrated no conflict, I have no idea what your complaint is. Your example fits perfectly with my point.

 

[russ_watters]

Russ, I'll just drop the poker analogy, but not because it's a bad analogy, it's because you never understood it since the beginning.

ok.

Stockholders need a benefit (i.e. be able to access the wealth of the company in any way) for holding a stock for your position to even have a chance to stand still.

Er, well, no. I know you are of the opinion that there is has to be a direct benefit to the stock for it to have real value, but as stated now it is just factually wrong. It's a fact that over time the stock market gains value, so it doesn't stand still. Perhaps you meant to say something else...

If there is no benefit, they're just trading pieces of paper...

Any document is "just a piece of paper". The title to your car and deed to your house are pieces of paper. But they represent something: ownership of a car and a house. A stock has value because the piece of paper is a contract that states how much of a company you own. Just like the deed to your house and title to your car.

...and that will never be anything else other than a zero-sum game.

You're now making straightforward arguments against reality. The claim that the stock market is a zero-sum game is factually wrong. The value of the market has risen. That's a historical fact. The discussion here is about why. Previously, you've argued that it shouldn't, while acknowledging that it does. You're slipping further from reality here.

Let me ask you this, though: is ownership of a car a zero-sum game? A house?

Whether the expectations of the investors are imaginary or not, independently of the reason of why they're trading, it'll always be a zero-sum game in respect to the profits. And no, more investors coming into the market doesn't change that fact as you argued before, independently of where they got the money (real economy or otherwise). That's by the way the reason I used the poker analogy, because more players coming into a poker game doesn't change its nature.

So back to the poker analogy. Still using it without explaining why the stock market is demonstrably not a zero sum game, but poker is.

You've seemed to go both ways with this analogy:
1. Both are zero-sum.
2. Both are positive-sum because of new players entering.

The problem is that it is demonstrable fact that poker is zero (negative in a casino) sum while investing is not.

If you have to understand my motivations for arguing, I'm arguing because I think I'm right, or I wouldn't be arguing...

I'm sure you do believe you are right.

...and because many stock traders take comfort in the illusion that the stock market is positive-sum game instead of taking comfort in their skill as traders.

And I'm arguing in large part to dispel this self-destructive myth of yours. Believing that investing requires skill above that of other investors in order to turn a profit (like a poker game) causes investors to make poor decisions with their money -- such as not investing in the stock market. This is important:

1. I have very little skill at "trading". On a typical year, I spend exactly zero time managing my investments.
2. My investments are growing.

Why? Because I know that you don't need to be a skilled trader to make money in the stock market.

Heck, investment magazines have proven that skill is not needed to turn a profit by literally throwing darts at a stock page and setting up game investments for the purpose of tracking how randomly chosen stocks do against managed stock funds. The dart board method held up well.

 

[Tosh5457]

You're now making straightforward arguments against reality. The claim that the stock market is a zero-sum game is factually wrong. The value of the market has risen. That's a historical fact. The discussion here is about why. Previously, you've argued that it shouldn't, while acknowledging that it does. You're slipping further from reality here.

I never made any statement that goes against reality, you just never understood them. Nothing I'm supporting implies that there can't be a long-term growth in stocks or any other asset.

Let me ask you this, though: is ownership of a car a zero-sum game?

Ok, I'm going to analyze 3 types of this game to make things clearer, but the analogy is only in line with the stock market case in the 3rd one.

If the car is owned by 1 person, and defining the utility function as being the objective value the car has loss over 1 year for example, it's a negative-sum game because the car devalues over time. So far so good, a owner of a company can lose without others necessarily winning and vice-versa.
But now let's introduce multiple "owners" and say that the "owners" can't use the car or take pieces of it. This is what effectively happens in the stock market, shareholders can't touch the company (except for majority shareholders or if they get together, which I'll get to later). If there is no market, they also can't trade the share they have of the car. In that case, no meaningful utility function can be defined, because nobody can get any utility of the car. What does it matter if the car deteriorates over the time if you can't do anything with it anyway?

Now to bring the analogy a bit closer to the stock market case, let's say the shareholders of the car can trade their shares with other people. Now the utility function has to revolve around the profit/loss they have in a currency or any other product (if they decide to trade it for gold for example), because that's the only utility they can get out of their shares. This game is zero-sum, what one wins came from other person.

Putting the analogy in line with the stock market, now let's say shareholders can get together and if anyone has 51%+ of the car's shares they can use the car, take pieces of it, whatever. The meaningful way to define the utility function in this case is: it's the objective value, measured in currency, that the car loses over a certain period of time for the shareholders that can use the car, and it's the profit/loss in currency for the shareholders who trade it. The shareholders that got together, went from a situation where they couldn't do anything with the car, except to trade the share they had, to a point where they can use the car. These shareholders won, while the shareholders that can't use the car didn't win anything. So with the utility function defined like this it's a positive-sum game. But before you only quote this part please read the rest: if you don't get hold of the car, by joining with other shareholders/having 51%+ of the shares, what you win will always come from someone else, so you're in a zero-sum subgame.
I've always focused in this case, because if you only analyze players who don't get together to control companies, it's a zero-sum game. And tell me, how often in the stock market regular traders get together to control a company? Even if there are traders who do that, if you're not one of them, you won't benefit and will be in a zero-sum subgame.

 

[nitsuj]

As the sole owner of the company, I absolutely do. You're describing a home equity loan except using a bar of gold instead of a house as the equity. Yes, I've done that. No, it doesn't, unless you worded that badly: The value of the bar doesn't change, its just that the ownership (or part of the ownership) of the bar changes hands. The bank gives you $x and they take ownership of $x of the value of the bar. If the value used to be higher, then the remaining equity that you own is now $y-$x. Total value unchanged. No, you have to forfeit the bar (or part of the bar) to the bank. That's what an "equity loan" is!
I'm not sure if you are calling failure to pay back a loan "stealing". I wouldn't but it doesn't matter either way: yes, the bank takes the bar of gold from you in a court proceeding of foreclosure.
Having demonstrated no conflict, I have no idea what your complaint is. Your example fits perfectly with my point.

of course I presumed "power to make decisions" was within the context of the law, as you should too.

I am calling what I described as stealing, simply because you are the sole shareholder doesn't make it legal for you to steal money from the corporation you own to pay for your personal house.

The bar of gold as equity represents a value, no different than a business using it's inventory to support a loan, which requires a continuous valuation of said asset. Same for the value of gold used to "back" a loan.


The law is what it is; despite how you feel about what your stocks represent. Which is NOT assets held by the corporation.

How do you fail to see this separation of asset ownership?

 

[enosis_]

of course I presumed "power to make decisions" was within the context of the law, as you should too.

I am calling what I described as stealing, simply because you are the sole shareholder doesn't make it legal for you to steal money from the corporation you own to pay for your personal house.

The bar of gold as equity represents a value, no different than a business using it's inventory to support a loan, which requires a continuous valuation of said asset. Same for the value of gold used to "back" a loan.


The law is what it is; despite how you feel about what your stocks represent. Which is NOT assets held by the corporation.

How do you fail to see this separation of asset ownership?

If someone owns 100% of a corporation - it would not be stealing to pay personal expenses - it would however require an accounting adjustment to explain a distribution of assets.

 

[enosis_]

This is a quick overview of how distributions are taxed.

http://www.googobits.com/articles/1371-how-are-dividends-and-other-corporate-distributions-taxed.html

 

[enosis_]

Removing the bar of gold from the company would probably fall into this category.

http://www.investopedia.com/terms/l/liquidatingdividend.asp#axzz2J2BWipEW

 

[enosis_]

the stock market provides people with a chance to make a fortune, but extremely unsure one.

Unlike a lottery where a $1 ticket could pay $millions, the stock market is more likely to return somewhere in the range of a loss and a 100% return (in my opinion of course).

 

[russ_watters]

Well, let's take some of the opinion out of it and look at what those probabilities really are:

Lotteries vary, but the average payout appears to be about 50%: http://blog.sfgate.com/pender/2012/03/14/georgia-tops-lottery-sucker-list-california-ranks-low/

That means that over the long-term, the average person can expect a net loss of 50% per play by playing the lottery.

Casino gambling is much better. Some bets have a pay-out of up to about 97%, meaning your loss is only 3% per play over the long term.

The stock market, over its history, has an average annual rate of return of +8%.

So let's say you start with $1000 and make 100 $10 bets the first year on a roulette wheel, then as many as you can after that, using the same pool of money once a year. At the end of 20 years, you can expect to be left with $53.

Similarly, if you buy $1000 worth of a highly diversified, un-managed mutual fund and just ignore it for 20 years, you can expect to be left with $5,030 at the end of that time.

Now neither of these are a guarantee of course, but the longer you stick to the plan, the better your odds are of getting closer to the average. What I can tell you is that never in its history has the US stock market had a 15 year period where a highly diversified group of stocks didn't turn a profit. Not even if you bought a bunch of stocks the day before the 1929 stock market crash. And if you invest the way most people do (a little at a time, at regular intervals), the risk is much, much lower.

 

[Vanadium 50]

What I can tell you is that never in its history has the US stock market had a 15 year period where a highly diversified group of stocks didn't turn a profit. Not even if you bought a bunch of stocks the day before the 1929 stock market crash.

This obviously must rely on dividends as well as capital gains. Since you have the data, can you check this for the 15-year period ending with the Dow's low of 41.22 in min-1932?

What I find surprising is that this discussion is focused almost entirely on capital gains. Dividends are very important. If I were to buy shares in, say, Coca-Cola, I would get 2.75% of my money in dividends. Even if I believed that the price of KO would be constant over time, this would be a good investment.

 

[russ_watters]

This obviously must rely on dividends as well as capital gains.

Yes.

Since you have the data, can you check this for the 15-year period ending with the Dow's low of 41.22 in min-1932?

Unfortunately, that's a paraphrase from a book. It doesn't have the actual numbers.

What I find surprising is that this discussion is focused almost entirely on capital gains. Dividends are very important. If I were to buy shares in, say, Coca-Cola, I would get 2.75% of my money in dividends. Even if I believed that the price of KO would be constant over time, this would be a good investment.

Meh - it was just a specific question.

 

[mheslep]

Here's a 15 year window on google finance for the DJI (no dividends) going back to '73. No losses for a 15 year window ever occur, though regrettably the lowest 15 year returns are recent. This past Summer-Fall had 15 year returns of 60-80%, lower even than placing the window close on the bottom of the crash in March 2009.

 

[Tosh5457]

Here's a 15 year window on google finance for the DJI (no dividends) going back to '73. No losses for a 15 year window ever occur, though regrettably the lowest 15 year returns are recent. This past Summer-Fall had 15 year returns of 60-80%, lower even than placing the window close on the bottom of the crash in March 2009.

That doesn't prove anything, as I said over and over, the stock market being a zero-sum game, excluding dividends, doesn't imply that stocks can't grow in the long term. I could also show a graph of any commodity future that grew for a long time, it doesn't make speculating in commodities futures a non zero-sum game. Somehow I get the impression many people are confounding zero-sum game with a game which in nobody can win.

 

[russ_watters]

Tosh, if you read the last few posts, that's a response to a different question.

 

[mheslep]

... No losses for a 15 year window ever occur, though regrettably the lowest 15 year returns are recent. This past Summer-Fall had 15 year returns of 60-80%, lower even than placing the window close on the bottom of the crash in March 2009.

That is to say, for the market (DJI) to be returning traditional 15 year returns it should be well above 20000 now.