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.
Unless you're an active day trader flipping penny stocks (and if you are, please understand the risks of penny stock trading), what happens in the stock market on one day or another probably isn't as big a deal as the financial news wants you to believe.
Yet as you can learn from One Up On Wall Street or The Little Book of Common Sense Investing, this doesn't have to affect your returns in the long term. It can even be a great opportunity for you to find bargains in the stock market!
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?
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.
On 1 March 2018, the president seemingly spontaneously announced tariffs on steel and aluminum imports. This has at least two implications.
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.)
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.
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.
For more details, see What Does a Trump Administration Mean for the Stock Market?.
Interest Rates Returning to Normal
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.
Of course, stocks going on sale can be a good thing, if you're ready for it.
China's 2016 Stock Market Crash
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.
This can be tough to watch. You hate to see a stock you spent time choosing and researching lose value, but keep the end goal in mind. Buy great companies. Stick by the simple rule that, in the long run, great companies thrive.
A Single Day in the Market Doesn't Matter
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.
Don't try to predict the market's gyrations from day to day. Invest for the long term. Pick good stocks by looking for good companies with plenty of room to grow. When stocks go up, celebrate. When stocks go down, watch and wait.
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.
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