401k 's, Pensions and the Equity Markets

There is an interesting article, by Roger Lowenstein in this week's New York Times Magazine, entitled "The End of Pensions?". In addition, to an excellent analysis of the current pension problem, Lowenstein has an interesting comment on 401K's and the stock market.

Below is a quote from the article:

"It happened that 401(k)'s, which were authorized by a change in the tax code in 1978 and which began to blossom in the early 1980's, conincided with a great upswing in the stock market. It is possible that they helped to cause the upswing."

This observation is interesting primarily because it points out what I believe to be the major reason why stocks go up: demand via money flow. In other words, stocks do not go up because a valuation is low or high, they go up because people are plowing excess cash into the market for a variety of reasons. At the same time, if people are not in the mood to play the market, because other speculative ventures have caught their fancy, stocks as a whole cannot go up.

I'm not quite sure how to turn these observations into money-making schemes. TrimTabs seems to attempt to do this with an analysis of fund flows and other money flow concepts. But, I've never found their analyses useful. In any case, the idea is to realize that classical valuations play little to no role in the appreciation of stocks. The key factor is the liquidity of the stock in question, i.e. is there more demand for the shares vs. supply.

Interestingly, it seems likely that the stock market as a whole has moved nowhere for several years probably because most people are putting speculative money to work in real estate, rather than equities. I don't know what will change this attitude. Until it changes expect little movement in stocks irregardless of valuations.

Also, Value Investing appears to work simply because it's adherents are buying stocks that are beaten down and have favorable supply/demand characteristics (i.e. there is little supply of the stock for sale and huge potential demand).  Therefore, when emotional sentiment towards these stocks change, and demand picks up again for the shares, there can be huge gains in the stock price.

The lesson: Look for beaten-down stocks that have potential growth, due to macro/industry factors, and have a story that can catch the attention of the financial gamblers. The trick is to buy these stocks when you have evidence that something will change in the coming years.