How is the stock market NOT zero-sum?

[David Sklansky]

"How certain are you that in the history of mankind, equity investment in businesses without management control has outperformed all other forms of passive investment? Or that it will?"

I am simply stipulating it. And I am also stipulating that there is no short selling. And I am also ignoring risk premium just as you do if you are playing poker.

With these assumptions you can then say that a random person who randomly buys and sell stocks and puts his excess cash in the bank will make more money than someone who doesn't play the game.

[DesertCat]

Anyone who thinks the stock market is zero sum does not understand the definition of zero sum. Stock market indexes have annualized returns near 10% (including dividends) over the last century and beyond. They have far outpaced inflation, have done better than bonds and almost every alternative. More value is created for participants every year because of the increasing earnings and asset values of the average component business.

Do some participants lose money? Sure, outcomes aren't identical. Is trading zero sum? Possibly. The biggest drag on returns is transaction costs, which eat up dumb active investors. But any participant can guarantee themselves market returns well above the risk free rate simply by buying and holding index funds for long periods(decades).

Imagine you ran into a friend who was part owner of a business and he offered you the opportunity to buy $1,000 worth of stock in it at book value. The business had a strong brand that served as a strong moat and helped guarantee high returns on equity. Let's call this business "Coke". Every year Coke earned 20% on equity, dividended half and reinvested half at the same returns. So your first year you expect to recieve $100 in dividends and for those dividends to double every seven years. Does that sound like a zero sum game? Sure your friend gave up access to that stream of dividends by selling shares to you but he probably felt he could create more value for himself by either through consumption (new car, house) or a better investment (college education or real estate opportunity).

If cokes shares suddenly become publicly listed it doesnt change much. Brokers will skim off some off the value in transaction costs for new owners of coke, and from former owners selling coke. But every year those coke shares continue to increase in value as dividends and equity increase. Some years people may pay only 5x earnings for those shares and some years the may pay 40x, some owners will get coke at bargain prices and others will over pay. But as long as they hold the stock the intrinsic value will grow.

[Phone Booth]

[ QUOTE ]
"How certain are you that in the history of mankind, equity investment in businesses without management control has outperformed all other forms of passive investment? Or that it will?"

I am simply stipulating it. And I am also stipulating that there is no short selling. And I am also ignoring risk premium just as you do if you are playing poker.

With these assumptions you can then say that a random person who randomly buys and sell stocks and puts his excess cash in the bank will make more money than someone who doesn't play the game.

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If you ignore risk premiums, then you'd also have to assume that the stock market will give you a return that corresponds to the risk-free rate. And your last sentence assumes that savings accounts and stocks are only passive investment vehicles.

[Phone Booth]

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Anyone who thinks the stock market is zero sum does not understand the definition of zero sum.


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Actually it's the opposite. Anyone who claims that an exchange of one financial asset for another is anything BUT a zero-sum transaction in terms of value doesn't understand the notion of zero-sum. Anyone who agrees with that, but claims that doing that many times over somehow makes the entire set of transactions non zero-sum doesn't understand mathematics.

[ QUOTE ]
Stock market indexes have annualized returns near 10% (including dividends) over the last century and beyond. They have far outpaced inflation, have done better than bonds and almost every alternative. More value is created for participants every year because of the increasing earnings and asset values of the average component business.


[/ QUOTE ]

And if everyone knew that this was going to happen in, say, 1900, would stocks have been priced where they were? You're confusing increase in value and increase in price. Nothing is *expected* to increase in value in vacuum - since that expectation is part of the value.

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But any participant can guarantee themselves market returns well above the risk free rate simply by buying and holding index funds for long periods(decades).

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Tried it in Japan, didn't work.

[ QUOTE ]
Imagine you ran into a friend who was part owner of a business and he offered you the opportunity to buy $1,000 worth of stock in it at book value. The business had a strong brand that served as a strong moat and helped guarantee high returns on equity. Let's call this business "Coke". Every year Coke earned 20% on equity, dividended half and reinvested half at the same returns. So your first year you expect to recieve $100 in dividends and for those dividends to double every seven years. Does that sound like a zero sum game? Sure your friend gave up access to that stream of dividends by selling shares to you but he probably felt he could create more value for himself by either through consumption (new car, house) or a better investment (college education or real estate opportunity).


[/ QUOTE ]

You're using different discount curves for yourself and your friend. If you engage in funny math like, a dollar is worth more to him than a dollar is to me, you can make a non-zero sum game out of any zero-sum game. It's not particularly reasonable or instructive.

[DesertCat]

BTW the quote that says the Dow has only increased 3x since 1900 when adjusted for inflation makes huge ommission that leads to the writers terrible logical error. It omits dividends which probably averaged over 3% per year during the century. This means an investment in the Dow with reinvested dividends would have increased about 100x in value adjusted for inflation over that century. The fact that the author did not understand this renders the rest of their post immaterial.

[CrushinFelt]

[ QUOTE ]
Actually it's the opposite. Anyone who claims that an exchange of one financial asset for another is anything BUT a zero-sum transaction in terms of value doesn't understand the notion of zero-sum.

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lol this is a really, really dumb argument to use

in fact, this whole thread is [censored] retarded... of course it's not zero sum, jesus christ

[Mark1808]

[ QUOTE ]
[ QUOTE ]
Anyone who thinks the stock market is zero sum does not understand the definition of zero sum.


[/ QUOTE ]

Actually it's the opposite. Anyone who claims that an exchange of one financial asset for another is anything BUT a zero-sum transaction in terms of value doesn't understand the notion of zero-sum. Anyone who agrees with that, but claims that doing that many times over somehow makes the entire set of transactions non zero-sum doesn't understand mathematics.

[ QUOTE ]
Stock market indexes have annualized returns near 10% (including dividends) over the last century and beyond. They have far outpaced inflation, have done better than bonds and almost every alternative. More value is created for participants every year because of the increasing earnings and asset values of the average component business.


[/ QUOTE ]

And if everyone knew that this was going to happen in, say, 1900, would stocks have been priced where they were? You're confusing increase in value and increase in price. Nothing is *expected* to increase in value in vacuum - since that expectation is part of the value.

[ QUOTE ]
But any participant can guarantee themselves market returns well above the risk free rate simply by buying and holding index funds for long periods(decades).

[/ QUOTE ]

Tried it in Japan, didn't work.

[ QUOTE ]
Imagine you ran into a friend who was part owner of a business and he offered you the opportunity to buy $1,000 worth of stock in it at book value. The business had a strong brand that served as a strong moat and helped guarantee high returns on equity. Let's call this business "Coke". Every year Coke earned 20% on equity, dividended half and reinvested half at the same returns. So your first year you expect to recieve $100 in dividends and for those dividends to double every seven years. Does that sound like a zero sum game? Sure your friend gave up access to that stream of dividends by selling shares to you but he probably felt he could create more value for himself by either through consumption (new car, house) or a better investment (college education or real estate opportunity).


[/ QUOTE ]

You're using different discount curves for yourself and your friend. If you engage in funny math like, a dollar is worth more to him than a dollar is to me, you can make a non-zero sum game out of any zero-sum game. It's not particularly reasonable or instructive.

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If the original seller of shares is required to buy back those shares or deliver the shares at a fixed point in time and all other market participants must settle up as well you have a zero sum game. If the original seller of shares and all market participants are not required to settle up at a fixed point there is no zero sum game. This is what differentiates options and futures markets with the stock or real estate market.


If I buy a piece of land, build a house and sell it we have a non zero sum game no matter what happens to price or value. The buyer of that house is going to make or lose money and there is no mechanism to insure that it will be offset by my gain or loss, or the gains or losses of anyone who subsequently buys the house. The game would become zero sum if the original home seller were required to buy back that house at a specific time, because his gain or loss would be exactally offset by the gains or losses of everyone who bought and sold that house.

[DesertCat]

I'm not talking about transactions, im talking about ownership. The increase in value acrues to the owners during their period of ownership. And this was understood in 1900 and has always been a known part of equity ownership. No one would take equity ownership in a business unless they expected higher returns than offered by more secure investments such as bonds.

And it has worked in Japan, once again you are ignoring dividends and where I said over long periods (decades).

And your math is funny. You can't dispute that a business like the one described would not increase in value dramatically over years and that value will accrue to the owners, that value is clearly not zero sum. I was just giving possible reasons a former owner could create more value by selling. They could be losers as well, it doesnt change the fact that ownership creates increasing value for share owners over time, in excess of inflation, and in excess of risk free investments.

[Phone Booth]

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And your math is funny. You can't dispute that a business like the one described would not increase in value dramatically over years and that value will accrue to the owners, that value is clearly not zero sum. I was just giving possible reasons a former owner could create more value by selling. They could be losers as well, it doesnt change the fact that ownership creates increasing value for share owners over time, in excess of inflation, and in excess of risk free investments.

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If the value *will* increase, it already has. And you're not understanding the implications of your statement that the former owner can create more value by selling, which is the key to your argument. You're saying that a dollar is worth more to him than it is to the buyer. That allows any game to be considered a non zero sum game. And I already mentioned an insider selling as one of the exceptions (but for entirely different reasons).

Ownership is irrelevant - change in ownership doesn't increase the aggregate ownership.

[Phone Booth]

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And it has worked in Japan, once again you are ignoring dividends and where I said over long periods (decades).


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Nikkei-225 is down for the last two decades and are you saying its dividend yield over those 20 years is high enough to make up for the risk-free rate over those 20 years? Note that Nikkei's dividend yield right now is below 1 and for all the talk of low japanese interest rates, it didn't get that low until 1995. Note also that really nothing catastrophic has happened in a long time.