Dave Kennon, Kennon Financial
Question from a reader: “Dave, why does the stock market go up and down? Fiduciaries, like yourself, always remind us to stay the course during volatility. But what creates volatility in the first place? If everyone is staying the course, why does the market move so much?”
Super Question! Let’s take a look….
1. Some economists believe it is simply a matter of supply and demand. If more people want to own a given stock versus wanting to sell a given stock, the price of the stock will go up. Just like Beanie Babies in the 1990’s. Supply was low, people went nuts over those adorable teddy bears, and the prices shot up. Then people came to their senses and realized a stuffed animal is not worth $500.
But this doesn’t explain why the stock market as a whole fluctuates.
2. Major world events. On 9/11 stocks lost 7.1%. The market was so volatile that the government shut down the exchanges until things cooled down. But this still begs the questions: Did Coca-Cola sell less sugary beverages or did McDonald’s sell fewer hamburgers due to 9/11? No.
So why did the market go down so much? People were scared. They didn’t know what the future would hold. Are we going to war? Are these kinds of attacks going to continue? The movement had nothing to do with the profitability of companies, but unadulterated human fear.
3. Speculation and day trading. In my opinion, this is what drives most volatility. Professional market traders and institutional investors base their buys and sell on possible future stock values. How do they do this? They look at trends and market environments and expected future profits from companies.
Right now super-smart-investor-people believe a possible trade war with China could impact the profitability of U.S. companies. But I can’t emphasize this enough- they are guessing. Who knows? The trade deal could increase profitability too. There are arguments for both sides.
They are not basing their decisions on actual financial data from companies. They are guessing what may happen in the future. This all sounds pretty fancy, right? The inconvenient truth is this: All this fancy prognostication, according to multiple academic studies, in no way increases the returns on their investments. But that doesn’t stop them from making the markets volatile with all the buying and selling.
4. Actual company profitability. This is probably the only legitimate reason for the market volatility. In 2008 when the housing market crumbled and the economy plunged into recession, actual company profits were affected. Dividends were cut, some bonds defaulted, and investments related to real estate were producing significantly lower returns.
But there are only a few instances in economic history where there were obvious economic factors in play.
2008: Real Estate Bubble
1973: Oil embargo, gas prices quadrupled, mass unemployment, the resignation of Richard Nixon, and the cost of the Vietnam War.
1943: World War II
1929: The Great Depression. Banks were poorly regulated, and over 8000 of them went bankrupt. This understandably created incredible panic, and the loss of people’s life savings. This took away the fuel needed to drive an economy.
With all of this being said, I often find myself yelling at the TV or in the newspaper. Everywhere I turn someone is giving their rationale for why the market went up or down that day. But the truth is 99% of the time, nobody has any idea what is making the markets move. The stock market is an incredibly complex system.
Think about it like the weather. Meteorologists will admit that beyond a couple days, predicting the weather is incredibly difficult. The weather patterns on this planet are utterly unknowable and unpredictable. There are just too many factors in play.
No matter what you hear, just say to yourself, “Even though there are men in suits on my TV who sound very educated, at the end of the day they are just speculating.
All I need to know is that markets might temporarily go down but they permanently go up. The stock market is an incredibly powerful way to grow my money. I don’t need to pay attention to the man on the screen. It has no bearing on my life or money.”
Dave Kennon, Kennon Financial
There is no certainty that any investment strategy will be profitable or successful in achieving your investment objectives. An index is a portfolio of specific securities. Indexes are unmanaged and investors cannot invest directly in an index. Index returns are “total returns” with dividends reinvested, which means the return is not only the change in price for securities but any income generated by those securities. The performance of an unmanaged index is not indicative of the performance of any particular investment. Investments offering the potential for a higher rate of return also involve a higher degree of risk. Past performance is no guarantee of future results. Actual results will vary.