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Examples of Market Inefficiencies

Posted in Money

Hope does not make you money in the stock market. There is a term used frequently on Twitter for people who buy into a “hot” stock and hope that the price goes up. They are called , “Bagholders.” Those who are left holding the bag, losing money, while other traders are making money off of them.

As you may perceive, we believe the market is inefficient. With this view, we believe there are many opportunities to make money. Fortunately, the U.S. provides enough freedom for everyday people to partake in some of these opportunities. Although there are restrictions in place that are not applicable to the “one-percent,” the market is accessible enough for one to participate. Here are some examples that I see.

Penny Stocks

There are thousands of stock in the major exchanges, like NYSE and NASDAQ. However, there are also thousands of stock in the minor exchanges. Stocks in these minor exchanges are sometimes referred as over-the-counter, bulletin board, or pink sheets. These are considered highly illiquid, low price stocks or penny stocks, and highly speculative. Because listing requirements are very lax at these minor exchanges, pretty much anyone can go “public” on these exchanges. Although there may be examples of valid companies listed in these exchanges, many are worthless.

These worthless companies often have no real business, where they do not earn any income, have no business operations, or the address of record is an empty lot. However, the listing will have some price associated with it. Although in our view, the company stock price should be $0 and remain $0, because of market makers, there will be bid and ask prices. Even if it is one-tenth of a penny, the price is marked above $0. If someone wanted to buy the worthless stock, they would have have to pay something above $0. The market maker will not sell the stock at $0, even though it is worthless. Common sense would tell us, why would anyone buy these penny stocks? We will get to that in the near future.

Negative Coupon Rate Debt

Government debt globally has been increasing at a dramatic rate. With low interest rates established by central banks, governments and corporations can sell debt at low rates or even negative rates. We have witnessed these incredible transactions take place in many instances. Briefly, these occur because financial institutions can borrow money at very low rates. With this money, they buy these debt from another country, with the expectation that the currency exchange fluctuation will give hefty returns. It is probably very complex and something that we as individuals cannot participate. Hard to imagine reasons why this would be considered efficient.

However, individuals living in the U.S. can purchase debt from the U.S. government. We can buy directly from the U.S. Treasury or buy through a financial institution. With low interest rates, it is hard to reason why one would purchase these. Recently, there has been a trend reversal where bond prices are dropping, which elevates the rate of return. We will have to see if the Fed will raise rates this month, as they have been hinting of raising all year long.

$TLT Source: finviz.com

$TLT
Source: finviz.com

India’s Monetary Policy

India has created artificial inflation due to their recent monetary policies. India has recently decided to cancel abruptly all their 500 and 1000 denominated banknotes. Without any time for a transition period or ample supply of replacement notes, this is causing chaos for millions of people in India. People wait in long lines to replace their now defunct notes, wasting a lot of man hours just to get legal cash. People who are able to use the old notes, will often have to pay a premium. Local businesses who rely on cash transactions, as they are too small to process electronic payments, report less customers and slower sales. Some news agencies report that it may take more than six months to produce enough banknotes to replace the old banknotes taken out of circulation. If prolonged, the GDP may suffer significantly.

Clearly, this monetary policy created chaos. The length of this chaos is still unknown, even though the Prime Minister provided a timeline of 50 days. I am confident that India and their people will bounce back eventually. It may take a little longer than 50 days in my opinion.

Next week, I will continue with the discussion of some pitfalls that an investor may face in inefficient stock markets.

Disclaimer: This is not a stock recommendation and I do not own any shares. Consult your financial advisor for any investment advice.

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