Odds and Ends

People often make rational economic decisions, even with large numbers. Take the Powerball lottery for example. The  chances of getting the top prize is understood to be one in 175 million. Many people are willing to play whenever the top prize exceeds that. After all, only when it is over 175 large is it a fair bet; and you are playing then with other people's money -- other people being the ones who played the previous 5 weeks and didn't win. But wait, there's more: the odds are greater than 50-50 that by the time the number rises to 175 million, you will be splitting the pot with someone else. This is because more players dive in.

You see, the Powerball market wants you to believe there is a rational play here, but there really isn't. Game theory aficionados will all see the fallacy of the numbers, and the play is limited to those who are bad at math.

Which brings me to the stock market. There are big numbers there, too, but the same people who rationally play when they believe the odds are in their favor are now jumping into a market after the odds of continued gain have clearly worsened. Like the Powerball game, there is only so much money to go around. Unlike Powerball, the prices of the tickets continues to rise, as the Fed stretches the asset bubble one more step.

Stock prices can continue to rise, in concert with the Federal Reserve moneyprinting. At some point, however, there has to be earnings that stay up with the valuations. This is where the game tops out. Earnings for the nation's corporations in the recent past are due to the fact that they haven't hired anyone or invested any money since 2009 (thanks to the uncertainty of Obamacare). Further growth from here depends on total wages going up. The Fed's strategy for that is to keep the printers going. However, the fiscal policy is to maintain uncertainty, so we sit and wait. Meanwhile, the price of a pound of bacon is $5.00.

One indicator of stock market valuation is Cyclically Averaged Price to Earnings ratio or Shiller P/E after the Yale economist who first reported it.

One figure to keep in mind. The average stock price to earnings ratio over the decades is 16.5. Today it is 25.4. If the earnings begin to fall faster (as I expect they will), we will be back up to 2000 dotcom numbers in a jiffy. Note that Wikipedia defines a jiffy as 3 × 10⁻²⁴ seconds.
When this snaps back, how is everybody who plays going to get their gambling money back? Answer: They're Not.