Follow This Reasoning
For over a century, economists, analysts and everyone in between has been trying to explain market movements and I am sorry to say, it all comes back to this simple axiom: Markets go up when there are more buyers than sellers and markets go down when there are more sellers than buyers. That’s it.
The actions that cause those imbalances in the demand/supply paradigm are somewhat more complex and this is where those super intelligent Harvard Business School lecturers fumble all over themselves.
Because the axiom is simple doesn’t mean the underlying forces have to be complex, they really aren’t.
You have the rush to buy something for several reasons. You believe in the business model of the company and believe it will have strong revenue growth and earnings growth over a period of time. Pretty simple.
You also might buy a stock because it is cheap relative to any number of measures that you follow. Not hard to understand that either.
Or, you are a day trader and you follow a herd of other investors and jump into a stock that has accelerating positive momentum. While everyone on every business network would have you believe that this is a new phenomena, it isn’t. There have been momentum stocks for as long as there have been stocks trading. Because momentum now is measured in milliseconds or minutes, it’s still lemmings following the herd. Sorry Robinhood.
I am sure there may be sub categories as well but pretty much any buyer in any stock falls into one of those three categories.
Along with the simplest explanations for positive price movement comes simple explanations for negative price movement.
An investor who is disciplined may sell because his/her price target has been reached.
An investor may be skittish about an individual company’s earnings or share prospects and reduce his/her holdings based on that.
Or, he/she can be part of some negative momentum movement and abandon the position that looked so promising 20 minutes ago. Again, sorry Robinhood.
Another key point is that selling usually happens faster than buying. Computer programs that have an outsized influence on markets are programmed to do certain things at certain price points and they are efficient in executing those instructions. However, the counter party programs are also efficient and when stock start to sell off, the programs designed to buy certain stocks over a period of time, tend to cancel or reprice their orders at a much lower level so you have a sell program designed to sell, with no price limitations and a buy program taking advantage of that “need to sell” and buying their respective stocks at a much lower level. That is why you see these unusually large moves to the downside periodically.
These programs can at times control markets but as was the case last week, buyers tend to show up at some point and create an upward draft. generally, these drafts take a bit longer to retrace a large downward move but they almost always retrace it fully.
Underlying these rebounds are several factors. One big one is corporate repurchases.
To say I am not a fan of the corporate buyback program is an understatement. Spending billions of dollars a year to increase shareholder value seems to me a lame excuse for lazy corporate management. Why not take those billions and pay your employees better, increase the benefits packages you offer, build a research capacity, look for possible takeover targets to increase your market share. Every move that in the longer term will increase corporate profitability and increased share price. I know it may seem hypocritical of me to say that considering that while on the trading floor my firm handled two of the largest corporate buybacks in history but that was then and this is now and at this time, I don’t believe that corporate buybacks help sustain a business. However, these corporate repurchase programs get accelerated during down times in the markets. That is one strong reason why even though I believe there will be a correction, it will be short. Corporations are sitting on hundreds of billions of dollars at this time. Be it from the US government or just plain profits, they have cash and this alone will prevent any serious meltdown in the market.
Another reason, and everyone will dismiss it, is there really is no better place to put cash to work. Again, very simple logic but it makes total sense. Bonds may be a safer bet but Treasuries are barely a factor for investment income. Corporates are better but the dynamic is moving away from them. Stocks are the easy pick. Be it through an ETF or a mutual fund, money is flowing in this direction and has been for 15 months. PE yields are high but not bubble high so whats the real risk? Thats the thought process when you have a market trading at or near all time highs.
Another sign of immense buying power still out there is look at IPO’s and look at Private Equity cash stockpiles. A rising ship takes on all comers and valuations are getting to a point where the possibility of a break increases.
Let’s take what the flood of IPO’s means first. Cash is looking for a home. New listings, new opportunities so you see every company with a balance sheet looking to go public, especially since the market is at such a lofty level. Private equity guys are moving these companies out to cash in and then they are flush with cash. So they keep looking and funding. This is all healthy for a national economy. It brings innovation to the masses and creates industries and jobs. It also makes some people very rich but in a full blown capitalist society, people will get rich, They get rich because they at some point took a major risk and they get rewarded.
Some estimates have private equity firms sitting on as much as 500 billion dollars in cash. I question that because these guys are smart and sitting on cash at some terribly low rate of return doesn’t seem smart. I think there money is working, maybe it is in stocks, maybe it is in several startups but I don’t think it’s in cash. Hedge funds are in a similar position and rest assured, they are buyers when the market tanks. Maybe they hold for a week of maybe they add to an existing position but rest assured, they are buying.
Over the years, one of the things I have learned is that when markets tank and you take a look at who was a buyer at the bottom, more often than not you will see sovereign wealth funds buying. Either the Saudi’s or the Norwegians or any number of oil rich nations, they all shift assets to the US. I am sure last week, these sovereign funds were very active and if there is another huge selloff, you will see them back in the market.
Given this basic understanding of market moves and market players I will in a later article give another simplistic explanation of volatility and it’s limits.