The Correction or What Happened?

Not a good weekend to look at our 401Ks or IRAs. The Stock Market went down about 10% in a week. Depending how it was invested so did our savings.

Company earnings have not dropped. Other country stock markets have not fallen much. The Economy is still doing well. Jobs and Wages are growing. What is causing the sudden change?

It is leverage, options and derivatives. These are higher risk borrowing and insurance without reserves. For instance if you knew absolutely a stock would go up 300% next week you would buy it now as an investor. If you don’t have enough money, you could borrow to buy more shares. That is leverage. The downside if share prices fell, you would still have to pay off what you borrowed and quickly. You sell whatever has value to cover your debts. You could lose 100%.

Most people don’t know they are buying derivatives. Most of us have been buying index Exchange Traded Funds (ETFs) or Exchange Traded Notes (ETNs). But now there are more leveraged ETFs & ETNs then there are stocks. Few non-professional investors understand what they own and the risks involved.

Warren Buffet has called derivatives “weapons of financial destruction.” Financial professionals have created “derivatives of derivatives” to further increase profits. However these are all powered by debt. At some point debt has to be paid.

A large number of investors have been improving profits by investing in low Volatility. Shorting VIX was the way this has been done. For the last few years it has been an ideal bet. Or was until a week ago. Some investors have lost 80% in a week. Some funds will liquidate and close.

Debt is the reason stocks fell so fast and may fall more. The average of corrections is 16%, but no correction is average. The correction may be done, or markets lose over 10% more into a recession (20% loss). Stock markets may start climbing again next week or next year. Anyone who tells you they know what will happen next is lying. Which is why am diversified and still investing for my retirement.

Simple Solutions Don’t Work

Tax the Rich - Connecticut and Maryland both found out this does not work.

Connecticut has raised income tax rates on wealthiest residence last 2 years. Net tax revenues have not increased. Tax revenue from the state's top 100 highest-paying taxpayers declined 45 percent from 2015 to 2016. The drop is a $200 million revenue loss for CT.

Maryland "millionaire's tax" pushed through by Gov. Martin O'Malley in 2007 imposed a rate of 6.25 percent on incomes of more than $1 million a year. ~300 richest residents would pay. The following year only ~200 high incomes had to pay. Result was a net loss of tax revenue.

What is happening?

First assumption is no one will adjust to higher taxes. Business owners and CFOs will find alternative methods to reduce taxes. If Capital Gains are lower, pay me in stock options instead of salary.

Second false assumption these wealthy people will make as much money every year. The wealthy are not the same every year. You only sell businesses and real estate every decade or two. Other years you earn much less.

Third wealthy people are mobile. They can move to another county, state or country. Record numbers of people have given up their US Citizenship in last 5 years. Some of these are people from other countries who built a business here, sold it and are moving for lower taxes on their windfall.

The other reason Taxing the Rich does not work, the wealthy don’t earn enough. John Stossel reports if the IRS took 100% of all incomes over $1 Million, the 2012 total would be around $616 Billion. The US Government had a 2016 deficit of $593 Billion and borrowed additional $830 Billion totaling $1.417 Trillion. About 40% of this year’s deficit.

John Stossel points out no one works to earn nothing, so those incomes would evaporate, resulting in No tax revenue to reduce the deficit.

People, businesses and corporations earn wealth. The government taxes and spends wealth for military, entitlements and programs. The government has to control spending.

The Biggest Risk to our Economy is Debt - personal, business and government. Next biggest risk is government regulations and spending.

Based on the slow growth of the economy over the last decade, your Entitlements will be Lowered and Taxes Raised by our governments.