What happened to the stock market today? Interest rates may rise in 2021. Tariffs and trade wars are here. The Coronavirus struck. Why is the market up or down?
The stock market is a collection of
countless transactions. It doesn't have an opinion; it has millions. It
doesn't have feelings. It's not a single thing and it's not a single stock and
it doesn't speak with one voice. Sometimes stocks go up. Sometimes stocks go
down.
Before you panic and sell everything (or rush out and buy everything, hoping
for a bounce), take a minute to catch your breath. Close your eyes. Go make
yourself a smoothie. There's no rush; the market will be there when you get
back. Ready?
The Coronavirus May Disrupt the Global Economy
In late 2019, the Coronavirus struck. Before the Chinese New Year 2020,
China had moved aggressively to build new hospitals and quarantine the ill to
reduce the spread of the disease. Other countries began to turn away travelers
as a precaution.
By late February 2020, fears of the disease's spread and impact caused many global firms
to worry about manufacturing and sales within China. For example, what happens to electronics
giants such as Apple if:
Their Chinese factories can't meet production goals, making fewer iPhones and iPads to sell
Their Asian customers aren't buying new iPhones and iPads because they're
spending their time and energy fighting the Coronavirus
Fears of a global pandemic may be premature, but a global economy built
around consumer confidence depends on consumer confidence being high. Swift
responses to the virus demonstrate that governments, researchers, and other
organizations will limit the spread and effect of the disease.
What will that cost the global economy? As of March 2020, the stock markets
aren't sure, because investors are pricing that uncertainty into the market. On
9 March 2020, market circuit breakers briefly halted trading after market
indexes plunged several percent.
On January 2, 2019 Apple CEO Tim Cook
published a
letter to Apple investors revising revenue estimates for Q1 2019 lower by
$9 billion dollars. Apple stock dropped around 10% on the news.
Apple joined the Dow Jones Industrial Average in March 2015. Since then,
it's contributed to a lot of the growth in the Dow. As Boeing and Apple have ups and downs in late 2018 and
early 2019, the Dow has reflected that volatility.
By the close of trading on January 3, 2019, the Dow looked to be down about 2.5%.
Apple's revised guidance reflects a couple of important things:
It's not selling as many iPhones as before
The US dollar is strong against foreign currencies (meaning that selling in foreign countries is less and less profitable)
China's economy slowed in 2018, producing fewer iPhone sales
While the first point may be specific to Apple, the latter two may reflect
macroeconomic woes that could affect many other global
businesses—especially those that rely on markets outside the USA for
significant revenue.
Donald Trump's Presidential Administration
On November 8, 2016, Donald Trump was declared to have been elected as the
45th president of the United States. During the evening and night of the 8th
and through the morning of the 9th, global financial markets lost a tremendous
amount of value—at one point, US markets had lost a trillion dollars in
one of the biggest crashes ever. While the overnight US markets showed big
losses, even hitting the circuit breakers, the day of November 9 closed with
the three major stock indexes up over a point each. It's too early to tell what
this means in the long term.
Some of this volatility reflects the uncertainty that switching the White
House between two major parties always provides, but it also demonstrates how
global markets see a Trump administration as unpredictable, unmoored, and even
dangerous. Investors seeking safer investments turned to the stability of
bonds, precious metals, and even cash while they wait to see what will
come.
By the time of Trump's inauguration and into the first months of his
presidency, broad market indexes climbed to new heights. Early conventional
wisdom suggests that all of his signals on reducing regulation and corporate
taxes would improve profits. Financial services, petroleum, private prisons,
and other market sectors saw even larger gains as the administration made
specific gestures to shuffle more money their way.
Throughout his presidency, questions arose from his handling of various
events, including one self-inflicted crisis after another. Tensions rose as he
fired Michael Flynn and then FBI director James Comey. The selloff on the
morning of May 17, 2017 occurred after reports that Comey was asked to drop the
formal investigation into Flynn. If these allegations are true, this could
represent the same sort of obstruction of justice which lead to the impeachment
calls and, ultimately, resignation of President Richard Nixon.
First, the cost of materials for large companies such as Boeing and Ford are
likely to rise. This will increase their costs overall and could reduce their
profits. With that said, companies such as US
Steel rose on the news, as their products could become cheaper in
comparison. (It's important to note that Boeing has buoyed the Dow Jones
throughout 2018, so any fluctuations in its price affect that market index more
than any other company.)
Second, given that the effect of tariffs is to make imported goods more
expensive so as to reduce the amount of goods imported, China may retaliate by
imposing its own tariffs. Who knows what those will be? Whatever the case, this
will make US goods less attractive in Chinese markets, and US companies relying
on sales in China will end up making less money.
By the 25th of June, 2018 the Dow Jones Industrial Average had posted losses
in 9 of the previous 10 days. With companies such as Boeing and Harley-Davidson expecting fewer orders or even
moving more operations out of the United States, the fears of a trade war
dragged the market down.
In short, the possibility of making less money (whether by selling fewer
things or paying more for materials) makes stocks less attractive, so their
prices tend to go down.
Political turmoil of this sort makes markets nervous. On 4 December,
President Trump tweeted about being "A Tariff Man". Unfortunately, this was
during a trade negotiation with China about removing tariffs. The
market sank because of the uncertainty about whether tariffs would go away or
increase. Given the vigor of his rhetoric, markets question whether his
administration can negotiate successfully with China.
The last week of January 2018 and the first week of February 2018, the Dow
Jones dropped several hundred points. It looks to close out February 2 down
hundreds of points, with other indexes (S&P 500, NASDAQ) to follow. While
this may seem like a crisis, it is more than likely to reflect
short-term investors taking their profits (in the long run up to this point)
and shuffling them to other types of investments to prepare for improved bond
yields.
One of the big drivers of the stock market since 2008 has been monetary
policy: in specific, the Quantitative
Easing program of the Federal Reserve and the low interest rates. While the
former put a lot of new money into bonds (keeping those interest rates low),
the latter kept the world's least risky investment paying out very little. As a
result, a lot of money chased better returns in the stock market.
With every indication that the Federal Reserve may raise interest rates,
savvy investors believe that stocks are a little less attractive. Why? Because
other, less risky investments, will start returning a little more.
This is a tricky and unpredictable line of thinking; you can easily get
yourself tied up in knots trying to predict what other investors will think
about the vague policy pronouncements some member of the Fed has made in a
speech here or there. The important takeaway is simple, though: money will flow
quickly to where people think they can get the biggest, least risky return. If
that's not Treasury bills (and it hasn't been for a long time), it'll go
somewhere else. As happened in early September 2016, the suggestion of an
interest rate hike by December 2016 led to a selloff on Wall Street.
Throughout 2017 and 2018, the Federal Reserve discussed a policy of raising
interest rates, as they'd been at historically low levels for a historically
unprecedented amount of time. Remember the correlation between interest rates
for US Treasury securities and stock prices—the more you can make with
safer investments (T-bills, bonds), the less attractive the risks of stocks
are.
In the long term, this may reflect that the Great Recession of 2008 is
finally over—especially given that the US economy has been at full
employment for a while. Time will tell what a new Federal Reserve chairman will
implement in terms of policy, but giving the Fed options to reduce rates again
as necessary is a positive sign for global economic outlook.
The UK Voted to Leave the European Union (#Brexit)
Of course, sometimes something happens. On June 23, 2016, voters in the United
Kingdom voted for their country to leave the European Union. Membership in
the EU means improved trade policies, less friction around goods and services
and people moving across borders, and (despite the economic kerfuffle around
different economic strengths and weaknesses between member countries) a general
sharing of wealth from multiple countries all working more or less
together.
Despite the UK's one-toe-in-the-water approach to the European Union, as
evidenced by keeping the British Pound instead of the Euro as prime currency,
the current state of the country is still tied to its membership. Trade deals
will have to be renegotiated. Tarrifs may be in play. The two year
process of political and economic disentangling is unprecedented, and that
creates uncertainty.
Whereas London was once the financial capital of western Europe, it remains
to be seen if it will continue to be the financial capital of the European
Union. Hence the drop in the value of the pound. Hence economic uncertainty for
all companies which do business in the UK or the rest of the Continent. Will
the UK fall into a recession? How will that affect global demand?
Even a good US stock with solely US customers may feel the ripple effects of
this uncertainty; our global economy means we're all connected.
As another example, China's
currency devaluation in January 2016 made the renminbi less valuable
compared to the US dollar—and made Chinese stocks look less worth owning.
This triggered a selloff in Chinese markets, and the volume of sales triggered
a circuit breaker which suspended trading.
That's a short term shock which makes a lot of people catch their breath.
When a country as big as China has a short term shock (even in stocks), a lot
of people in other countries get nervous. It's not just stocks, either; the
price of oil has dropped dramatically in recent months—good for a lot of
people who consume oil (airlines, transportation, individuals), but
bad for people who produce oil (oil-rich countries, petrochemical
refineries).
China's a particularly pernicious example, as it's still destroying
its stock market in order to save it. If the economic powerhouse that is
China suffers from economic turmoil, that'll affect global demand. The world's
just digging itself out of an economic crisis from 2007, so investors are
rightly concerned about global stagnation.
What Happened to the Stock Market Today
What the market did today is a combination of the decisions of hundreds of
thousands of people.
Everyone seems to have an explanation for why stock prices rise and fall.
People are happy about the economy. People are worried about the economy.
People want interest rates to rise. People want interest rates to fall. Europe
looks good. Europe looks bad. Canada's raising tariffs. Canada reported
extraordinary growth. Company A met its earnings goals. Company B didn't.
Inflation numbers looked bad. Inflation numbers looked good. Gold is hot.
Silver prices fell. Oil supplies are running low—or high. Unemployment
numbers changed too much or too little. Euros went up against the dollar. Who
knows?
These contradictions suggest that post-hoc explanations are
guesses.
Any of the measurements people quote—any of the stock market indexes which go up and down—are
just measurements. They're averages. They're big bundles of numbers all mixed
together. In all truth, they only reflect a snapshot of a point in time.
They're numbers that stocks happened to end on when trading stopped for the day
(or, at least, paused until after hours
trading took over).
Maybe Coca-Cola announced record earnings.
Maybe it's the middle of the month, and your 401(k) contribution has just come
out of your paycheck, so you
automatically bought a fund or individual stocks. Maybe you've just
retired, and you'd like to take 40 years of profits to pay off your mortgage,
so you're selling some stocks. Maybe a stock hasn't gone anywhere for you, and
you don't mind taking a little loss for the tax break. Maybe you found a
bargain and you just can't wait to snap up a few shares. Maybe it's a stock
bubble or stock valuations are running high.
Some of these motivations come from people all following each other, trying
to predict the exact economic actions of other people all engaged in the same
activity. (People who bought a stock at too high a price are looking for
greater fools to unload it on.) While the market's open, everyone's trying to
figure out the optimal value for the price of every stock everywhere. It's
exhausting to think about the trillion or so variables that go into that
immense labor of capitalism. It's crazy to consider how complicated the chains
of cause and effect and overthinking are.
Why Does the Market Go Down?
Remember that the market as a whole is a complicated system; a huge
collection of thousands of stocks and funds and futures and derivatives. You
might look at an index like the Dow Jones, S&P
500, or the NASDAQ and it will move in a direction opposite of another
index.
If the market went down, is it because one company changed its business
model or its forecasts? Because a mutual fund changed its strategy? Because a
glitch triggered a wave of selling? Because yesterday it went up a lot and
people decided to take their profits and invest elsewhere? Because one large
investor decided to cash out on high valuations? Because another round of stock
options for Facebook employees matured, and they
sold? On the whole, we can't say why the market went down today is due to a
single reason.
Why Does the Stock Market Crash?
This guideline has one exception: a stock market crash. If the market as a
whole, measured by all three major indexes, loses hundreds of points (multiple
percentage points), there's generally been a shock to the system, such as 9/11
or an unexpected political development or absolutely terrible economic news,
such as the collapse of a major currency. In recent memory, bugs in automated,
algorithmic trading have caused smaller crashes.
These events happen, but they're inherently unpredictable. That's
why they happen. Recovery happens too.
In recent years, the SEC has approved automated mechanisms to halt trading
in event of wild swings in stock prices. These mechanisms are known as circuit
breakers, curbs, or collars.
Since February 2013, the broad market has three circuit breakers tied to the
performance of the S&P 500 index. If it loses 7%, 13%, or 20% of its value
compared to the previous days close, trading halts for a period of time. If
anything can be considered a stock market crash, it's hitting these circuit
breakers.Remember, Black Monday (October 19, 1987) saw the DJIA lose 22.6% in a
single day.
Why Does the Market Go Up?
It's impossible to point to a single reason why any of myriad measurements
of the stock market increase or decrease in a day. A company releasing great
news about its business might draw more investors to buy its stock and push up
the price, but you can't tell if they're speculating or if they've analyzed the
stock and its financial basics and really believe it's a good price now.
If you have to ask "What do other people see in this stock?", they're
probably hoping they can sell it to you later by making it look more attractive
than it is. Tread carefully.
Stock Prices are Irrational and Unpredictable in the Short Term
Over time, we can correlate historical trends in the stock market
to the global business cycle. When times are good, stocks as a whole tend to go
up—bull
markets. When times are bad, stocks as a whole tend to go down—bear
markets. This doesn't predict the behavior of any individual company's stock
over time, however, nor does it suggest what any stock will do on any given
day.
Predicting a stock's daily changes is a guess. Some people will justify it
with formulas and predictions and complicated examples, but they're looking for
patterns in random fluctuations. Yes, if good news comes out, a stock price
might rise the same way that if bad news comes out, the stock price might
fall.
Does it matter what the market did today? Not really—not compared to
what the companies we own will do in the coming years. Why did the
stock market go up today? Who knows. Why did the stock market go down today?
Who can say?
Leave questions about
money supply and the Federal Reserve and unemployment rate and all of those
airy factors to economists. Let other people second guess everyone else. We
prefer a measured approach, one which gives our portfolios more stability
against the daily (hourly) rise and fall of trader sentiment.
Benjamin Graham once observed
that in the short term, the stock market is a voting machine. That's what it
did today. It went up or went down based mostly on popular opinion, blown by
the wind. In the long term, it's a weighing machine, which reflects the true
value of businesses in their stock prices. That's why it's so important to
think like an owner, and not just a trader.
To become a good investor, you must look beyond the irrationalities of the
stock market day by day. Instead you seek to understand the real value a stock
represents: ownership of a company with a solid plan to build lasting
wealth.
Remember: the so-called stock market is one of many, many measurements of
dozens or hundreds or thousands of companies in countless industries. Some
businesses are great. Some businesses are poor. Some are growing. Some are
shrinking. Some of their markets are disappearing. Others are expanding. We can
examine history to explain what the market does over time, but we cannot
predict a single day.
With a little bit of discipline and hard work and knowledge, you found a
great company at a good bargain worth your time investing in. It's a boring
strategy, but it's a great way to find a good yield while keeping your money
safe.
