Stock Market Woes Again
Last Friday the Dow Jones Average fell some 500+ points in one day. That is a lot. Over the weekend, pundits breathlessly characterized the fall as “correction like” but technically not a correction. Monday was worse for China are the US stock markets dropped over 500 points. Hmmm. What were these markets trying to say?
Stock markets are places where most people pretend to make investments (buy or sell stocks for example) when in reality they are making “bets” (wagers). The bet is that an hundred dollar investment will in a short time be worth $200. The thinking goes that when the stock reaches $200, the investor will sell and pocket a profit of $100. Pretty simple and easy to understand how one would make money.
The “bets” can drive the average stock price up and up. Remember, when the price rises, someone has also decided to sell thereby taking his/her profit. At some point the average price is viewed as too high and then the market physiology reverses this process and prices drop. Normally the drop is just a little, these past few days it has been a lot.
Not so long ago (ok, well maybe it was 50 years ago), individuals and conservative investors preferred dividend bearing blue chip companies. These companies were stable and regularly paid a dividend. The overall quality of the company investors chose was important. The stock value appreciated but only slowly, so investors tended to hold onto these stocks for a long time. The investor made money from dividends and a little appreciation when the stock was finally sold.
Not any more. Investors want to make money much sooner and quarterly dividends are not enough. Investors care little about the long term prospects of companies they invest in. It’s all about how much can be made now. Putting things in perspective, most banks are paying less than 1% on savings, yet stock market investors are hoping for double digit returns (although they will settle for 5+% if they must.
The “stock market industry (the wide range of media, analysts, and financial advisors)”, works hard to make the investment process sound complicated, almost seemingly to make us look the other way when these panics occur. Potential investors are told to look (with the help of an advisor) for “undervalued” stocks or stocks in certain fast growing fields like energy, transportation, or maybe real estate. Investments in those fields are most likely to appreciate in value future investors are told. Advice abounds that conditions remain favorable for growth and it is not too late to “get in the market”. Hmmm.
Compared to China, Wall Street caters more to the “institutional” investor rather than the average individual (mom and pop) investor. Mutual funds as well as hedge funds make most of the Wall Street trades, and make them electronically. Ironically, empirical data shows that funds which mimic the overall averages of sectors or the market as a whole do as well or better than investments by individual expert’s picks. So, indexed funds must be safe? Hmmm.
Lets look at China which is turning an unsettling light upon stock markets. In China, most investors are individuals who make their own trades. The Chinese stock market process has looked more like a casino where “you place your bets and pick up your winnings”. “Don’t have enough money, no problem, just borrow and invest”.
With the overall Chinese economy having been growing at almost 10% per year, experts could predict with some certainty that stocks would be worth more next year than now. Growth rates of 10+%, however, are simply unsustainable and while China has enjoyed over 10 years of this type of growth, China’s growth rate has receded recently to the 7-8% range. While still the best in the world, pundits worry that China’s growth rate will fall further. What about the possibility that the market is already over priced?
The stage has been set. China’s stock market, loaded with borrowed money and with investors who have had no clue why stock prices were as high as they were, are poised to panic. Like with the US market, the heavy hitters all play the same game. “Get in the market first, get out of the market first. leave the losses to others”.
Last into the market and last out of the market is a prescription for losing a lot of money. Accordingly, when market watchers see the market go down, the urge to panic and sell sets in. How far of a drop the Chinese market must endure before the “correction” is complete is unknown. What can be counted upon is that market makers will reenter the market at some point and be set to ride the market up again, all the while encouraging average people to invest. The many who have been investing with borrowed money (especial if buying on margin), will likely be wiped out during the current “sell phase”.
The market’s herd mentality, however, can not be denied.. If an investor gets out early, he/she can watch the stock drop further and see others try to emulate the “pros”. Even if the investor gets out too soon, as long as the market does follow him/her to lower levels, these investors will be poised to jump back in and benefit more from a rising market.
The moral of this story is there are no market fundamentals, indicators maybe, but no primary calculations which can inform on when to buy and when to sell. Further there is only money to be made if there are buying and selling cycles. If stocks are high (as measured by market averages and specific stock’s historic record), sell and put money aside. When stocks seem low, buy and hold until stocks seem high, then sell and count your profit. The obvious problem is recognizing the high point and the low point.
Listen carefully what the pundits say over the next few days. Many will tie the drop in US prices to the drop in China’s stock market or China’s overall growth rate (the fear card). This is pure malarkey. The US has a much more diverse economy and while China is an important trading partner, it is only one of many.
A far better explanation lies in the herd effect (one sells, we all sell) and the reality that a steep correction (large drop) just creates more room for speculators and market makers to make a killing on the way back up. Hopefully your financial advisor is not recommending “rebalancing your portfolio” which of course involves selling. The wise investor is already “diversified” and should be able to wait out this current Wall Street chill.
Lastly, the pundits may predict tough times ahead because a slowing Chinese economy will have knock on effects in the US. The notion is that US business earnings will decline. Hmmm. Maybe but just how much? Some corporate earnings may be less with a slow or not growing China, but that should be only a small fraction of US companies. And more to the point, betting on future earnings growth should remain unchanged. Without a doubt there will be confusion around a slow down in China, but US fundamentals seem as sound as the ones that got the Dow Jones to 17,000+ in the first place.