by Archie M. Richards, Jr., CFP^®
October 22, 2001

During some of the stock market's sour September days, you may have wondered why "curbs" were imposed.

This meant that traders had to quit drinking for the rest of the day.

No, it didn't. It meant that arbitrageurs could no longer engage in program trading. During any day in which the Dow rises or falls by at least 210 points (a number that's reset every quarter), the exchange halts program trading lest it cause prices to change even more.

Program trading usually involves both stocks and the futures market. An S&P 500 futures contract, for example, costs relatively little money down. But if you hold it to maturity, you're committed to buy all of the stocks included in the index. At current prices, this would cost you about $268,000 just for one contract. If you sell such a contract, you're committed at maturity to sell all of the S&P stocks.

When a fund manager expects the market to decline temporarily, the sale of his stocks would incur excessive transaction costs. Instead, the manager sells futures contracts and later buys them back before maturity. If he anticipates the market correctly (who can do this consistently?), he'd be buying the contracts low and selling them high, with the selling done first. The futures profit offsets the stock portfolio losses.

Program trading aligns the futures prices with the values of the underlying stocks. If the price of a futures contract gets too low in relation to the underlying stocks, arbitrageurs buy the contract and sell short the stocks, pulling the contract price up and stock prices down. If the futures price gets too high in relation to the underlying stocks, arbitrageurs buy the stocks and sell the contract, pulling the stocks up and the contract down. Program trading represents about 20 percent of the New York Stock Exchange volume.

Curbs on program trading occur fairly frequently. But this trading is done by people with enormous resources. For regular investors, neither program trading nor the curbing thereof has any effect at all.

Don't shy away from small stocks. Normally, their PEs are approximately 18 percent less than those of the biggies. But now, they're about 48 percent less. Small companies are cheap.

In November 1998, U.S. tobacco companies agreed to cough up a quarter-trillion dollars in damages over 25 years. The four giant companies - Philip Morris, R.J. Reynolds, Lorillard, and Brown & Williamson - have since enjoyed handsome profits. In light of the massive damages, how come the big profits?

The four biggies knew they'd have to raise cigarette prices substantially to cover the damages. But how to prevent smaller tobacco companies and importers from offering lower prices and taking away business? Here's how: The big companies formed a protectionist racket with state governments.

The 1998 Settlement Agreement requires all tobacco companies with U.S. sales to pay damages. For those that signed the agreement, the damages are tax deductible.

Companies that didn't sign the agreement must pay damages anyway, but their payments are placed in escrow to offset liability that might later be assessed. The payments in escrow are not deductible - a big incentive for companies to sign.

The smaller companies that did sign the agreement are permitted to expand their markets, but only by 25 percent. Here's the hooker. The four big companies control more than 96 percent of the market. Let's say a small company has 1 percent. It can increase its share all the way up to 1.25 percent. Big deal. The agreement prevents small companies from effectively competing against the big ones. It prevents the small guys from becoming big guys.

The state governments handed the big four tobacco companies a cartel, protecting them from effective competition. The states rake in almost a quarter-trillion dollars over 25 years, and the scumbag tort lawyers grab $750 million a year for the first five years and $500 million a year thereafter.

Everyone wins. Everyone, that is, except the consumers, especially poor consumers, who are the principal smokers. Over 25 years, they have to fork over an extra quarter-trillion dollars in higher prices.

The 1998 tobacco settlement is a flagrant example of a general truth: Big government sucks wealth from the poor and serves it on a platter to the rich.