COUNTERCOLUMN: All Your Bias Are Belong to Us

From a reader:

Your interest in finance has led me to be so bold as to ask if you have any thoughts on how much the creation of IRA's has fuel the stock market boom of the past twenty years. If IRA's have driven the boom, what effect can Social security have on the market in the future.

No pressure, just curious if you had opinion. Thanks again

Oh, I'm not really the person to ask. But I don't think IRAs are what launched the secular bull market which began in 1982.

For one thing, IRAs came into being in 1974. And for years, IRA limits were only $2000 dollars per year. Further, the market plunged into bear territory even as the Bush tax cuts became a reality, increasing allowable IRA contributions by 150% over four years. So IRAs could not have been a huge factor.

The boom coincides more with the advent of 401(k) plans. But even then, I think they only created a marginal increase in demand for equities. Talk to the labor unions and the liberal economists and they'll argue that 401(k) plans largely displaced traditional, defined benefit pension plans. So there's even a real question about to what extent 401(k)s represent real, new investment, vs a simple redirection of investment dollars from corporate control to worker control in 401(k)s.

I think the increase in equity prices was fueled by a combination of factors, including

1.) Reductions in long-term capital gains rates from 45% in 1974 to just 15% / 5% today. Which creates a much stronger incentive to invest capital rather than consume it.

2.) Hard money monetary policies initiated beginning with the Volker Fed in 1980-81 which finally broke the back of inflation and drove down interest rates, and bolstered the credibility of the dollar in international markets.

3.) Other tax cuts, combined with large scale deficit spending.

4.) A check on wage inflation, which tended to transfer wealth from workers to owners of capital, and naturally had to show up in share prices.

5.) New technologies, such as the computer, improving productivity and efficiency across the board.

6.) Developing economies for the most part recovering from the financial crises of the early and mid 1980s. This increases demand for US products and equities.

7.) An emerging middle class in Central America and Asia, which again increases demand for US products and exports.

All these things had a much larger effect on the bull market since 1982, in my opinion, than the advent of either the IRA or the 401(k).

I don't think Social Security reform will make a perceptible dent in holding up large cap equity prices or bond market prices. The market, I think, can absorb the increase in investment.

I think we may see some reduction in the risk premium in small cap markets, if Social Security moves money into that sector. If Social Security doesn't have a small cap option, we may see a more noticeable jump in prices of midcap securities when they approach or enter the bottom rung of the S&P 500 or whatever benchmark large cap index we choose. A modest arbitrage opportunity for active traders and hedge funds, but not a big deal in the grand scheme of things.

Jason