Don't Let the Tax Tail Wag the Dog

 The headline for this blog is one of the golden rules of personal finance. It means you should never make an investment or financial decision based solely on minimizing taxes. While tax-efficient investing is smart, making decisions purely to dodge the tax man (IRS) often leads to taking on needless risk, holding onto losing assets, or missing out on better returns. All too often, a smart, successful person holds on to a stock for far too long because selling would trigger a capital gains tax. Say a stock holding was up 400% at its peak. Then it falls in a precipitous manner, and now it's up 30%. They still won't sell because they are hopeful of a reversal back to their previous high level. Eventually, there is a realization that the reversal is not forthcoming. The stock is back to its cost basis. Our investor has lost years of potential returns, all to avoid a tax bill that would have been a fraction of the ultimate damage. This is the tax tail wagging the dog.

Before proceeding further, it probably makes sense to introduce the applicable income tax rates to the discussion. Capital appreciation (when investments go up in value and the gains are realized) is taxed at your capital gains tax rate. There are short-term gains and long-term gains. If an asset is bought and sold within one year, it will be subject to short-term capital gains. Generally speaking, this will be the investor's marginal income tax bracket. Investments that are sold after being held for more than one year will be subject to long-term capital gains. There is preferential tax treatment as it will be lower than your marginal income tax bracket. The applicable capital gains tax rates are itemized below. Please note the taxable income parameters are for single filers.

LT Capital Gain                                                                                                                                                  Tax Rate                                  Taxable Income    

-0-                                            $0 - $49,450                

15%                                         $49,451 - $545,500

20%                                          over $545,500

Besides the obvious example as detailed previously in the first paragraph, there are other common mistakes associated with holding on to securities at all costs. One risk is that it can get in the way of your overall investment strategy. Rebalancing a portfolio is a critical part of any investment strategy. Rebalancing goes hand in hand with asset allocation and diversification. Over time, certain asset classes will increase in value compared to others. This can disrupt the original asset allocation that was chosen when your strategy was determined. While this is a good thing, normally the advice is to return the portfolio to its original strategic asset allocation. This involves selling appreciated assets - which means paying some capital gains taxes. Paying taxes is the price you pay to participate in the equities market and, even more specifically, the price you pay to keep a strategic asset allocation over time. It is never enjoyable to write a check to the Internal Revenue Service. However, you're paying taxes because you made money (which is the goal) based on either a smart or lucky investment decision, and that sure beats being on the losing side of a trade.

Several years ago when I was a young banker and novice investor, my late father was always pestering me to purchase municipal bonds. Many investors buy munis because the interest income from these bonds is generally exempt from federal income taxes. My reluctance to buy municipal bonds at a fairly young age was supported by multiple considerations. First of all, I wanted the risk/reward associated with the stock market. Second, the commissions charged when buying munis can be fairly stiff. Lastly, I simply was not in a high enough federal tax bracket to justify an allocation to municipal bonds. Munis are inherently more valuable the higher your marginal tax rate is. Another consideration would be that changes to the federal tax code can draw investment monies into bad deals that would never attract attention except for the favorable tax treatment. Always run the investment through a non-tax filter first. Ask: Would I own this if there were no tax benefits? Still another example of chasing "tax-free' growth would be over-funding whole life insurance policies. The returns need to be evaluated honestly against alternatives. The question is always, "Is this a good use of my capital?"

Investors would be wise to consider future tax risk. There is a strong possibility that in the not-too-distant future, income derived from long-term capital gains will be taxed at a much higher rate than is currently the case. In the 1970s, long-term capital gains tax rates were over 30% - peaking at 39.875% in 1976. It would not surprise me in the least if we see a return to those much higher rates. With a national debt of $40 trillion and annual budget deficits consistently around $2 trillion (6.5% of GDP), there will be increasing pressure to increase taxes. The growing wealth inequality will reach the point where Congress will modify the tax code to address this issue before social unrest leads to violence on our urban streets. I expect the top 10% of income earners, especially the top 1%, will be paying significantly more in income taxes in the next few years. It might even be worse than I am predicting. Can you imagine the tax rates for wealthy Americans if President Mamdani has a Democratic House of Representatives and more than 60 Democratic Senators in the United States Senate?

I'll end this blog with a comment I came across when reading an article for research I was conducting on this subject matter. " The best tax shelter of all time is a great investment. Don't contort your portfolio into unrecognizable shapes trying to avoid taxes. A well-diversified, well-managed portfolio that grows steadily will always outperform a tax-optimized portfolio of mediocre investments."

Beware of IPOs

 IPO is an acronym for Initial Public Offering. An Initial Public Offering is when the stock of a private company is sold to the public. In other words, the company becomes available for the public to invest in via the stock market. As if the equities market isn't animated enough sitting at all-time highs, currently there is a tremendous amount of buzz surrounding three companies going public in 2026. Those companies are Space X, Anthropic, and Open AI. Space X launched June 12, 2026 and already has a market capitalization of $2.65 trillion. Space X's value currently makes it the world's fifth-largest publicly traded company, leapfrogging Amazon and within spitting distance of Microsoft. Last year, Space X took in $18.7 billion in revenue and lost $4.9 billion, while Amazon took in $717 billion and earned $77.7 billion. Anthropic and Open AI both formally filed their form S-1s with the SEC in early June. They are projected to go public in the last quarter of 2026 and first quarter of 2027, respectively. Both of these companies are expected to top the $1 trillion market cap level right out of the gate. Needless to say, this 2026 mega-IPO bonanza is unprecedented and crazy.

If you would have invested $10,000 in Amazon at its IPO price of $18 per share in May 1997, you would have approximately $28,500,000 today. If you had invested $10,000 in Netflix at its IPO price of $15 per share in May 2002, you would have approximately $7,200,000 today. If you had invested $10,000 in Apple at its IPO price of $22 per share in December 1980, you would have approximately $26,400,000 today. It's easy to see with these three examples why people get so excited about IPOs. So, why am I extremely cautious with IPOs and why do so many well-known investors just say no and refuse to touch an IPO, any IPO, with a 10-foot pole.

There are multiple reasons why IPOs should be avoided. They often feature inflated opening valuations driven by media hype and usually arrive on the scene when market excitement is at its peak (sound familiar?), selling incentives are high, and valuation discipline is low. Traditionally, by the time a company goes public, the easiest money has already been made by the founders, insiders, venture capitalists, and the investment banks who underwrite the stock issue. IPO shares are generally only available to high net worth investors before they become available to the general public via the stock market. Furthermore, the underwriters often price the stock aggressively, leaving little room for immediate growth and making the stock vulnerable to steep sell-offs once the initial excitement wears off. In other words, average retail investors frequently get hung out to dry.

Newly public companies lack a proven track record as a publicly traded entity. Without extensive historical price data, their stock prices can swing wildly on IPO day and during the weeks that follow, making them a risky proposition for long-term or conservative portfolios. Early insiders, executives, and major investors are often subject to "lock-up periods" (typically 90 to 180 days) during which they cannot sell their shares. When these restrictions expire, a flood of new shares can hit the market, causing the stock price to plummet.

In general, IPOs disappoint investors with poor returns. According to Verdad Capital, the median IPO (out of 3,700 IPOs reviewed since the late 1980s) lost 31% of its value three years after its IPO. After five years, the loss was even greater at 41%. In a Dimensional Fund Advisors' (DFA) article titled, "IPOs: Profiles are High. What About Returns?", DFA reviewed approximately 6,400 IPOs from 1991 through 2018. Their research concluded that the collective group of IPOs underperformed the broad stock market (Russell 3000) by 2.20% per year. To put that into context, an investment of $100,000 into IPOs would have been worth $653,000, while the same investment in the broad stock market would have been worth $1,155,000. If you are going to take on the additional risk associated with IPOs, you better make sure you will be compensated for it.

If my powers of persuasion have not convinced you to avoid buying an IPO, then I offer the following bits of advice:

1.) Wait. Let the market determine the stock's true price as opposed to the price the investment bank initially sets. Wait until after the lock-up period ends. Sit back and evaluate a minimum of two or three quarters of earnings before serious consideration is given to the purchase of shares. 

2.) Only invest in an IPO with money you can afford to lose. Don't use your "serious money" such as a retirement nest egg.

3.) Keep your fingers crossed.

Batting Average vs. Slugging Average

 One of the biggest misperceptions in the field of investing and trading securities is the viewpoint that investors have to be right nearly all of the time to be deemed successful. In other words, they have to accrue a batting average that reflects vastly more winners than losers. The batting average for an investor is derived by computing the number of investments that make money as a percentage of total investments made. In baseball, a 0.400 batting average would be considered the holy grail. This was last accomplished by Ted Williams in 1941. The argument can be made that Ted Williams was the greatest hitter of all time. In the world of investing, a 0.600 to 0.650 batting average is considered top-tier, while professional investors often look for at least 0.500. This tells me that picking winners in the stock market is considerably easier than hitting a major league curveball.

In both baseball and investing, the slugging percentage supersedes the batting average in terms of importance and relevance. On a baseball diamond, the slugging percentage measures a hitter's batting productivity, and it differs from batting average because it values hits differently by weighing them differently. A single is worth one base, a double is worth two bases, three bases for a triple, and accordingly a home run is worth four bases. The total bases are the sum of singles + (2 x doubles) + (3 x triples) + (4 x home runs). Slugging percentage is the total bases divided by the number of at-bats for a player, ranging from 0.00 to 4.00. A player near the -0- level will soon be looking for a new day job. While a player at or near the 4.00 level will most assuredly be a deity. In general, a high slugging percentage tends to lead to more runs being scored and to winning more games.

Concerning investments, the slugging average is the average absolute gains for successful investments divided by the average losses for unsuccessful ones. This would apply to both realized and unrealized gains and losses. The key to investment success is ensuring when you have winning ideas, they are big positions generating outsized returns (e.g. doubles, triples, or home runs), and when you have losing positions, the positions become smaller (singles). Your losses are minimized and do not significantly matter. Thus, the best investors focus more on "slugging average" - the magnitude of gains - rather than just the frequency of winning trades.

What you're looking for are multi-bagger winners that go 3x, 4x, 10x, and more. Multi-bagger winners drive the majority of returns for exceptionally robust investment portfolios. Although multi-baggers don't grow on trees, they are out there just waiting to be discovered. My Achilles Heal is that I tend to prematurely realize relatively decent gains by selling early, and then rebalancing and reallocating to other positions. This approach does not allow gains to run, and sometimes they run wild. A case in point - I bought Meta (formerly FaceBook) in 2013 for $28 per share and then promptly sold it for a modest profit a few months later. A second case in point - I bought Micron in 2018 for $52 per share and then sold it a year later at a 20% loss. It is too painful for me to write down the current share price for those respective companies.

One of the key insights thus is that an investor can be correct much less than half of the time, with say a 0.400 batting average, and still generate high returns if the winning trades are significantly larger than the losing ones. Listed below are a dozen quotes from legendary investors that pertain to the subject matter of this blog:

1.) "Even the best investment analyst is going to be right just two out of three times." - Sir John Templeton

2.) "Most traders make money only in the 50 to 55 percentage range. That means you're going to be wrong a lot. If that's the case, you better make sure your losses are as small as they can be, and that your winners are bigger." - Steve Cohen

3.) "No investor can be right all the time. If an investor is correct half of the time he is hitting a good average. Even being right three or four times out of ten should yield a personal fortune if he has the sense to cut his losses quickly on the venture where he has been wrong." - Bernard Baruch

4.) "I am a professional mistake maker. One third of my trades are probably wrong." - Ray Dalio

5.) "I always say to people who come in to see me that you have to realize in our business a really, really good person is wrong 30% of the time. That's a world-class investor. Are you comfortable being wrong 30% of the time? By the way, you can't be wrong in a massive way." - John Phelan

6.) "It's not whether you're right or wrong that's important, but how much money you make when you're right and how much you lose when you're wrong." - George Soros

7.) "If you're terrific in this business, you're right six out of ten." - Peter Lynch

8.) "During 68 years on Wall Street, I have been wrong about 30 percent of the time. That means a lot of losses. But it's the 70 percent right that matters. If any investor had been right all the time, he or she would have accumulated a considerable portion of the world's wealth. But as you might suspect, always-right investors don't exist, except among liars." - Roy Neuberger

9.) "Our portfolio managers have a tough job as you are wrong half the time. They get a report card every day that is an F. It happens to be that 53%/47% still is very profitable in finance, but it's still a tough report card. We hire the best and brightest and they go from having 90's as their average test score to 53%." - Ken Griffin

10.) "John Templeton said something to me a couple of years ago - he said if you are right 60% of the time and wrong 40% you will be a hero, and if you are right 40% and wrong 60%, you will be a bum. But I am sure he used more gracious language than that." - Peter Cundill

11.) "Five to one means I'm risking one dollar to make five. What five to one does is allow you to have a hit ratio of 20%. I can actually be a complete imbecile. I can be wrong 80% of the time, and I'm still not going to lose." - Paul Tudor Jones

12.)"So you have flops. Maybe you're right 5 or 6 times out of 10. But if your winners go up 4-or10-or 20-fold, it makes up for the ones where you lost 50%, 75%, or 100%." - Peter Lynch

Financial and Economic Illiteracy

 Based on policies and decisions emanating from the federal government during the first quarter of the 21st century, it is obvious to many that our leaders at the national level, for the most part, are intellectual lightweights and believe the citizens they represent are primarily disengaged idiots. I wouldn't go quite that far, but there is sufficient evidence to support the contention that roughly half of Americans are financially illiterate and lack even an elementary understanding of economics.

 American exceptionalism does not extend to dominance in the rankings of financially literate adults by country. The Scandanavian countries, followed closely by Canada and Israel, are the "cream of the crop" when it comes to financial knowledge. The United States languishes in 14th place, stuck between the Czech Republic and Belgium. In general, men are considered more financially literate than women, White and Asian Americans are considered more financially literate than Black and Hispanic Americans. Before stringing me up for being a sexist racist, I will go on record for saying these differences are not due to genetic reasons, but rather due to systemic and socioeconomic factors. Since I've opened the generalization box, I'll also mention that members of Gen Z have the lowest level of financial literacy, while Baby Boomers exhibit the highest level. This is not surprising, considering the priorities of our educational systems and the fact that wisdom is accrued over time. Among U.S. adults, risk comprehension is the weakest point of their financial literacy. Only 36% of U.S. adults answered related questions correctly.

The impact of financial illiteracy on financial outcomes is both obvious and impactful. According to the National Financial Educators Council (NEFC), a lack of financial knowledge costs adults $948 annually on average. Limited or no financial knowledge often leads to costly choices for individuals and the country as a whole. Too many Americans have excessive debt levels, and the majority feel anxious about their finances. Over 42 million Americans are carrying student loan debt, with the average student loan borrower owing $39,075. Over 14 million Americans have more than $10,000 in credit card debt. Wages not keeping up with inflation is obviously a major factor, but lack of financial knowledge contributes as well.

Even many Americans who have jobs that pay way above-average compensation struggle with establishing a savings program for present-day expenses and for retirement down the road. A surprising number of households with significant income generation live paycheck to paycheck. Part of the reason for this phenomenon is attributable to something known as "lifestyle creep." As income rises, so do expenses, with high earners spending on luxury items, upscale housing, extensive travel, and other pricey lifestyle choices. High debt levels are often incurred to fund expensive primary and secondary residences, six-figure vehicles, and tuition payments for children attending prestigious universities. Money management skills are often lacking among the high income earners that find themselves living paycheck to paycheck.

There are steps that can be taken that will hopefully improve our abysmal financial literacy rates. According to NEFC, nearly half (44%) of 18-34- year- olds said their high school didn't offer a personal finance course. Many who had the option to take a course but decided not to wish they had. Early education is key to success. In 2024, 35 states required K-12 students to take at least one personal finance course to graduate. That's up from 23 states in 2022, a step in the right direction. The internet is also a great source for advancing one's financial knowledge. Although that comes with the caveat that there is also a surplus of junk and voodoo economics in this area of the internet. That said, there are also a number of reputable financial podcasts that can be extremely educational and helpful. My favorite is "Thoughtful Money" featuring Adam Taggart. Still another source for improving financial acumen would be the vast number of published books that deal with personal finance and economics. Lastly, among U.S. adults who are knowledgeable about personal finances, 49% say they learned a great deal or a fair amount about personal finance from family and friends. My advice to a young person would be to ask a ton of questions and entertain a wide variety of opinions from family and friends who at least understand the basics of economics.

I hesitate to include professional financial advisors on the list of potential sources in which to enhance one's investment acumen. There has been a proliferation of salespeople masquerading as financial  advisors. Salespeople are not inherently bad, evil, or ne'er-do-wells. They simply have a job that creates conflicts of interest that are detrimental to the financial planning process. All too often, they fail to take a wider view to improve their clients' chances of accomplishing their objectives by offering solutions that are often outside the range available to sales-oriented representatives. I've also thought that too many financial advisors, at least when it comes to investments, prefer to keep their clients in the dark and incapable of truly understanding the nature of their various investments. I would be remiss if I didn't acknowledge that there is a modest percentage of financial representatives that are talented and always act in a fiduciary capacity for their clients. They are the exception, and not the rule.

Besides financial loss at the individual level touched on earlier in this blog, widespread financial illiteracy also poses a risk to our economic and social systems. Congress may be a check and balance on the executive and judicial branches of the government, but the people are the check and balance on Congress. The short-sighted and unwise policies that economists deplore often turn out to be immensely popular with voters. Why should we think that politicians fail to listen to the voice of the people when heeding the voice of the people is the usual path to political power in a democracy? Politicians listen all too well, and as a result, they heed to a host of economically illiterate demands.

   

   

How Money Is Created

 Money is ubiquitous and fungible. It also plays an important, if not dominant, role in practically everybody's life. A minuscule number of individuals (economic nerds), however, truly understand how money is created in our financial system. The process by which the money supply of a country is increased or decreased is important in understanding how an economy functions. Before proceeding with the details, I should mention I am specifically addressing money creation in the United States. Most other countries with a central bank operate in a similar fashion, but this blog will only pertain to the United States.

The majority of the money supply that the public uses for conducting transactions is created by the commercial banking system. This is done by commercial banks exercising their lending function. Bank loans expand the quantity of bank deposits. Our system of banking is called fractional reserve banking because banks only keep a fraction of deposits as reserves, and they loan out the rest. A bank creates new money merely by issuing a loan. The amount it creates is limited by the reserve ratio or "fraction" it is required to maintain to cover its cash-flow needs and comply with standards mandated by its regulators. With a general industry reserve ratio of 10%, then each $100 it lends includes $90 that never existed before. A commercial bank, therefore, can create a sizable amount of money merely by making loans. Conversely, money is destroyed when bank loans are paid off by borrowers or charged off by the lender.

In the world of dollar creation and destruction, the "Wizard behind the curtain" is America's central bank, the Federal Reserve Bank. There are multiple levers the Federal Reserve can pull to influence the nation's money supply. One way a commercial bank can expand reserves and make even more loans is to borrow funds from the Fed. This process is called going to the "discount window." When a bank goes to the discount window, the bank is expected to pledge collateral. The collateral can be government bonds, but it commonly consists of commercial loans. The Fed then grants credit to the bank in an amount equal to the debt instruments. This allows the bank to convert its old loans into new reserves. Every dollar of those new reserves then can be used as the basis for lending nine more dollars in new money.

The Federal Reserve Bank is the banks' bank. That is, banks hold deposits at the Fed much like you or I might hold deposits in a checking account at our local bank. From its inception in 1913 until October 2008, the Federal Reserve never paid a penny of interest to its various depositors (commercial banks). That all changed a month after the collapse of Lehman Brothers during the throes of the Great Financial Crisis. On October 6, 2008, the Federal Reserve began paying interest on depository institutions reserve balances (both required and excess). The program is known as the Interest on Reserve Balances (IORB). This tool allows the Fed to implement monetary policy by influencing short-term interest rates. The higher the interest rate the Federal Reserve offers to pay its member banks on their reserve balances, the less likely it is for the banks to lend money to private borrowers. Banks are generally unwilling to lend to private parties at a rate lower than what they can earn risk-free on reserves at the Fed. If the Federal Reserve wants banks to lend more of their deposits, thereby creating more money, all they need to do is lower the IORB. And that's exactly what they did during COVID. In January 2020, the interest rate on reserves was 1.55%. By mid-March 2020, the Federal Reserve had dropped the rate to 0.1%.  

The Fed can also manipulate the amount of reserve deposits in the financial system by purchasing or selling bonds (primarily Treasury securities) in the market. This is referred to as open market operations. When the Federal Reserve buys bonds from banks they digitally create new money out of thin air and exchange this new money for the bonds that are then included on the Fed's balance sheet. An increase in bank reserves theoretically increases bank lending and in turn increases liquidity and the money supply. This open market purchase strategy is known as Quantitative Easing (QE) when it is pursued on an aggressive basis for an extended period. QE during the financial crisis (2008-2009) added about $3 trillion to the Fed's balance sheet. The COVID crisis triggered the addition of another $5 trillion to the Fed's balance sheet. From January 2020 to January 2022, the M2 money supply increased from $15.4 trillion to $21.6 trillion. That's a 40% increase in the money supply - unprecedented in recent U.S. history.

There are risks associated with an insufficient money supply, but it happens so rarely in history it is not worthy of discussion. The historical problem, however, which we happen to be currently experiencing, is excessive money supply with more most assuredly coming down the pike. Excessive money supply growth, when outpacing economic output, triggers inflation, erodes purchasing power, and causes currency devaluation. To quote Milton Friedman: "Inflation is always and everywhere a monetary phenomenon." When too much money chases too few goods, prices invariably rise. High money growth often precedes inflation by roughly a year. This was seen in the 1970s when inflation hit double digits and hung around for a few years at dangerous levels. It was also evidenced in 2021-2022 when inflation went from 2% to 9%. This was triggered by the massive (40%) increase in the money supply in response to the COVID pandemic. Consumers painfully discover their cash buys fewer goods and services. Excess money and liquidity can also flow into stocks, real estate, and other assets, creating asset price bubbles. Sound familiar? 

Although it will never be acknowledged by the leaders of either of our major political parties, it is my opinion that the government will continue to run the economy hot and intentionally target an inflation rate of 3% - 5%. Inflation works as a "soft default" on current debt since the real value of the debt is repriced. The total real liability of the current federal debt decreases by 19% with an inflation rate of 5%. Inflation acts as a mechanism that reduces the consequential debt-to-GDP ratio. It also effectively transfers wealth from holders of government debt (creditors) to the U.S. government (debtor). Inflation is an insidious, hidden tax that decreases the purchasing power of the populace. Using inflation to reduce debt is a blunt, dangerous tool that ultimately can serve as a catalyst for a fiscal crisis and significant social upheaval.

Reversion To The Mean

 A powerful phenomenon exists that is often ignored or overlooked during both bull and bear markets. This is possibly the case because many investors prefer a sappy narrative to an analysis based on mathematics and historical data points. In a financial context, "Reversion to the Mean" describes the tendency of a stock or stock index price to return to its average or "mean" value after deviating from it. This behavior is based on the premise that extreme price movements are often temporary and unsustainable in the long run. The basic principle is that what goes up must come down, and what goes down must go up. While the daily movements of the stock market may be chaotic and unpredictable, long-term stock market returns tend to follow a somewhat predictable upward trend. Deviations from this trend can last for extended periods, even decades. Mean reversion is not a consistently viable strategy for short-term trading. On the other hand, it is useful in identifying individual security valuation and overall market valuation relative to historical trends. 

The concept of mean reversion was first observed in the field of biology by Sir Francis Galton, a cousin of Charles Darwin. In his book, "Hereditary Genius" (1869), Galton set out to prove that human ability passes through the generations. He found some confirmation that the descendants and relatives of distinguished people were likely to contain great achievers among them. The effect, however, diminished over time. Only 36% of the sons of eminent men and only 9% of their grandsons were eminent. Galton also discovered that the same principle holds true for height. The children of abnormally tall people tend to be smaller than their parents, and vice versa. Without regression to the mean, the world would comprise of geniuses and dimwits, and giants and midgets, with nothing in between.

Examples of reversion to the mean abound. Major League baseball players who hit well in their rookie season are likely to do worse in their second season. The acclaimed "sophomore slump" is more than a myth. Likewise, regression to the mean is an explanation for the Sports Illustrated cover jinx - periods of exceptional performance resulting in a cover feature are likely to be followed by periods of more mediocre performance, giving the impression that appearing on the cover causes an athlete's decline. The hottest place in the country today is more likely to be cooler tomorrow than hotter. Another example, returning to the financial realm, would be the best performing mutual fund over the last three years is more likely to see relative performance decline than improvement over the next three years. The "Dogs of the Dow" investment strategy incorporates reversion to the mean to a certain extent. This strategy selects the 10 stocks in the DJIA at the beginning of the calendar year with the highest dividend yield. The theory holds that those companies are near the bottom of their respective business cycles and would thus exhibit a lower share price than if they were near the peak of their business cycles. The 10 companies near the bottom of the business cycle should have their share price appreciate more quickly compared to the other 20 companies in the Dow Jones Industrial Average.

Mean reversion investment strategies often incorporate specific technical indicators in the process of trading equities. These indicators help identify overbought or oversold conditions. The most prominent tool in this area would be the Relative Strength Index (RSI). The RSI is an oscillator that measures the magnitude of recent price changes to evaluate overbought or oversold conditions in the price of a stock. It fluctuates between 0 and 100. A high RSI (typically above 70) suggests the asset is overbought, while a low RSI (typically below 30) indicates oversold conditions. Traders adopting a mean reversion approach might buy when the RSI is low, anticipating a price rebound, or sell when the RSI is high, expecting a price correction. Another technical indicator used on a frequent basis would be Bollinger Bands. Bollinger Bands consist of a moving average and two standard deviations plotted above and below the moving average. These bands widen during periods of high volatility and contract during periods of low volatility. A stock price moving outside of the Bollinger Bands can signal an overextended move, suggesting a potential mean reversion opportunity.

In discussing Bollinger Bands in the previous paragraph, the term "standard deviation" was mentioned. In the world of statistics, standard deviations measure how far from the normal trend line data points have strayed. Two standard deviations cover 95% of all events and three standard deviations cover 99.7% of all events. The S&P 500 Index is currently 2.3 standard deviations above its historical trend line. The last time it pushed above two standard deviations was when it hit 2.2 standard deviations just prior to the Internet Bubble bursting in 2000. As a reminder, the NASDAQ lost 80% of its value during that particular drawdown. So, be careful, market participants.

For a long time, a popular strategy in the investment world was to simply buy solid companies and tuck them away forever. That's what was considered prudent investing. Investors didn't understand that bad companies are often too cheap and good companies often too expensive. The assumption was that companies would maintain a constant return on their retained earnings. The ROE is never constant, however. It's always changing. There is a systemic tendency for high returns to fall and low returns to rise, in both cases regressing toward the typical corporate return. Capital moves towards profits, whether it be in certain sectors or specific corporations within the sector. This leads to complacency among the "winners" and attracts new competition. It becomes more difficult for the wildly profitable entities to maintain their margins. Lower margins lead to lower stock prices.

Multiple studies confirm that the rate of mean reversion was not identical for every company. There are  two primary factors that can either accelerate or decelerate the pace of regression. Debt, especially a high level of leverage, speeds up the regression rate. The profits of a highly leveraged company are going to drop much faster when things turn bad compared to a company with little or no debt. The firms that display the qualities of a monopoly can slow mean reversion to a glacial pace. These companies are the price-setters in their industry with a dominant market position. Refer to multiple members of the Magnificent Seven (Meta, Google, Nvidia) for prime examples. So far, they appear immune to mean reversion. Their day will come. It's hard to defy the Laws of Physics. It's also hard to defy the Laws of Math and Statistics.

K-Shaped Economy

 One of the biggest economic buzzwords the past few years has been "K-Shaped Economy." Take a second to picture a K. The one line shooting up and to the right represents Americans who are financially doing great. They're mostly people who are heavily invested in the stock market, and that market continues to break records. And the line shooting down? That's pretty much everyone else. Essentially, the rich are getting richer, the poor are getting poorer, and the middle class is shrinking. The number of Americans considered to be middle class shrank from 61% in 1971 to 51% in 2023 according to a 2024 Pew Research report. While United States income inequality has trended higher for the better part of a half-century, the split between the haves and have-nots has become even more pronounced since the Covid-19 pandemic. Of even greater concern is the widespread prediction that the divide will continue to widen in the ensuing years. Following, I will look at the primary factors contributing to the growth in income inequality. After writing about the causes, I will go over some of the possible ramifications to the economy and society in general if the income/wealth chasm is not successfully addressed. Lastly, I will list a handful of possible solutions to close the gap.

The main culprit for the expansion and acceleration of income/wealth inequality is, of course, our federal government. The central planners in Washington D.C. have flooded the economy with government spending of all sorts and inflated the money supply via artificially low interest rates and QE for the last quarter of a century. These abhorrent fiscal and monetary policies have been especially egregious since the Covid-19 pandemic. The majority of Americans, especially working class Americans, have not recovered from the inflation surge precipitated by the government response to covid. While inflation has since moderated from its highs in 2022, the 25%-30% cumulative price increases since 2020 have been devastating to most household budgets. One-hundred dollars in 2019 has the same buying power as $127 today. Rising prices have largely eaten up wage gains, leaving low and middle income Americans struggling to make ends meet. A softening labor market along with fears that Artificial Intelligence adoption will displace large swaths of workers further sours many Americans outlook on their future financial prospects.

The "haves", on the other hand, are prospering and optimistic about the future. While lower-income households are increasingly relying on debt to make purchases, higher-income households are maintaining or increasing their spending levels. The top 10% of income generators are responsible for 50% of consumption on a national basis. This group is essentially "carrying" the economy and keeping it out of recession. Cumulatively, this richest 10% of American households also owns 70% of the nation's wealth. Over the past five years or so, a soaring stock market along with rising real estate values have generated more than $50 trillion in new wealth. Nearly three-quarters of the growth in consumer spending this past year can be attributed to what economists call the wealth effect: as people's net worth rises, they spend a fraction of their increased wealth. Asset owners, holders of stocks, bonds, and real estate, have made out like bandits the past few years. The same can't be said for Americans who own little or not assets.

The artificially low interest rates perpetuated by The Fed have directly fueled the staggering increase in asset values. Rates were depressed for over a decade (2008-2022). Multiple rounds of Quantitative Easing (QE) have also contributed to asset inflation. More and more monies chasing a finite number of assets has pushed stock markets and real estate prices into the stratosphere. That's great for homeowners, people with stock portfolios, and the wealthiest 10% who hold most of the country's wealth. The same can't be said for the seniors with modest savings accounts who rely on social security benefits and the young adults looking to form a family and to have children. There is a reason why about one in three U.S. young adults (ages 18-34) live with their parents. I can fully understand why members of the Millennium generation and Generation Z are miffed with the Baby Boomers.

History shows that excessive income concentration can weaken economic growth by lowering overall demand. Those with fewer resources depend on borrowing and accumulate debt until it's no longer possible. When these imbalances become unsustainable, the economy typically shifts from boom to bust. There is also no question that grossly unequal distribution of income and wealth can facilitate political polarization and tear at the social fabric of a nation. I don't see a second American Civil War or something like what happened in Russia in 1917, but capitalism will continue to be under threat as old coots head to either the nursing home or the cemetery and younger voters cast their preferences at the ballot box. A case in point would be the recent election of Zohran Mamdani in New York City. It would not surprise me to see additional politicians getting elected across the country who share Mamdani's socialist views.

Flattening the K-Shaped economy may be crucial for the nation's long-term economic and political health. A key question is whether technology (Artificial Intelligence) will help flatten the K-Shaped trend or do just the opposite. The cynic in me believes AI will exacerbate the problem. Although the government tends to make problems worse when it attempts to solve them, look for the government to introduce measures in an attempt to flatten the "K." This will primarily be done by revising the tax code with the goal of reducing wealth and income disparities. Fixing our antiquated, wasteful, and corrupt education system at all levels would hopefully facilitate a narrowing of the divide and offer disadvantaged students the possibility of dramatically improving their financial situation. In reality, the only surefire way to fix the problem is for deficits to be reduced, end The Fed's interventions, return to sound money, and let interest rates be determined in the markets. Don't hold your breath.

I offer the ultimate solution to the problem. However, most of my peers, if not all of my peers, are not going to like this quick and brutal solution. We could use a good, old-fashioned recession. One where overvalued real estate loses 30% of its value and the supremely overvalued stock market loses 50% of its value. I don't anticipate this happening. At the first signs of trouble, Congress will recklessly expand the annual deficit from 6% of GDP to 12% of GDP, while The Federal Reserve Bank cranks up the printing presses and floods the financial system with even more excessive liquidity. In other words, the proverbial can will get kicked down the road. Again.