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ONCE YOU GET BEYOND index funds, I’m out of my league, so I ask this as a naive investor. Can someone please explain the stock market to me? Okay, I guess that’s a trick question—because I don’t think anyone can explain the financial markets to anyone.
I’ve heard that markets are forward-looking. If that’s true, how come stocks react wildly to information that has been publicly anticipated for days, even weeks? Why the big surprise?
Take inflation. It’s high, we all know it’s high, and we all know it’ll take time to bring it down. Yet the day after an announcement that inflation is no better than the previous month, the markets tank. Who’s not paying attention to the news?
I’m mystified when the price of a stock falls because the company’s earnings miss analysts’ estimates. Why can’t it be that the analysts messed up and the company is doing just fine?
The price of a stock fluctuates mostly based on earnings and anticipated earnings. Why? If a company beats its earnings estimate, why should its stock price rise? Investors are willing to pay more for a company with growing earnings, I’m told. But even if earnings rise, an earnings announcement can tank the price of a stock if the company’s profits are off by a few cents a share—in a single quarter, no less. It sounds like pure gambling to me.
Ah, earnings. Why should I care about earnings, anyway, if they’re not shared with me? I like dividends, at least they’re real. The company gives its shareholders some of what it earns. On the other hand, if earnings are rising and dividends are not, we’re back to the never-ending argument that earnings growth leads to higher stock valuations.
It’s even more mystifying when a company pays no dividend while its stock soars—in anticipation of what? Dividends someday? The anticipation of higher earnings can cause a stock to rise, yet still there’s no dividend. The company is reinvesting in the business, we’re told. What does that mean to me?
By themselves, earnings are suspect. How were they generated? Was there a stock buyback that increased earnings per share without a rise in overall profits? Or maybe expenses were cut, layoffs conducted. Seems to me such earnings are bogus.
I track one stock closely, my former employer’s. It accounts for 40% of my non-retirement investments. The stock has paid—and increased—dividends for 115 years. I’ve been reinvesting mine in more shares for the past 52 years. I’d say that’s a pretty stable stock.
Yet, within the past six months, the “experts” have set target stock prices of $87, $84 and $75. As I write this, the share price is $62.85. At the same time, the recommendations have been to “buy,” “hold” and “sell”—sometimes all at the same time from differing analysts. What value is there in all these predictions? What are average investors to think, or is all this guesswork for traders betting on a 50-cent change in share price?
At the end of the day on Sept. 20, The Wall Street Journal reported, “Stocks fell Tuesday ahead of the Federal Reserve’s next policy decision as investors grappled with the impact of rising rates on corporate earnings and valuations.” Wait, investors were surprised? And, again, there’s that obsession with short-term earnings.
On Sept. 21, the markets were up at noon, even though everyone knew the Fed was meeting that day and likely to raise interest rates by 0.75 percentage point. The headlines blared, “Another big interest rate hike is coming.” No surprise at all. Sure enough, interest rates were raised exactly as predicted and the markets dropped—big time. My question is, what did investors learn at 2 p.m. that they didn’t know at 1:59 p.m.?
Is there any wonder that many Americans are afraid of investing in stocks, or react irrationally when they see a decline in their 401(k)? Is there any actual difference between New York’s “Street” and Las Vegas’s “strip”?
Richard Quinn blogs at QuinnsCommentary.net. Before retiring in 2010, Dick was a compensation and benefits executive. Follow him on Twitter @QuinnsComments and check out his earlier articles.
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I’d say 100% of business reporting about the stock market is total BS.
As Paul Merriman says, there’s always “List A the good news” and “List B the bad news.”
But financial “journalists” have to write something, so they 1) observe a movement in the market, 2) blame bad current events for decreases in stock prices or good current events for increases in stock prices, and 3) hit publish.
I get a warning from Personal Capital (an online money/investment account aggregator) that I have too much single stock exposure (which is my only individual stock). They are right. But it’s in Berkshire Hathaway and I trust them. Other than that, I’m in index funds.
One day the market dropped 1,000 points and I found out about it a week later (after the market had “rebounded”). A local college basketball coach had a player who was physically topnotch but mentally not too quick. Opposing players had a hard time faking him out because he just wasn’t picking up their moves quickly. As the basketball coach said, “It’s hard to fake out someone who isn’t paying attention.” I’m sure that ties together with my not realizing the market had dropped 1,000 points.
You ask many good questions about the ever-surprised stock market. I worked for a company in trouble that engineered “expenses cut, layoffs conducted” every spring for years before the fourth quarter earnings were released. It made all the employees cynics.
For everyone commenting “in the long term stocks always go up,” my questions are: isn’t it possible the “always go up” situation could come to an end in the U.S./the world? (Do I hear everyone answering “No!”?) What if one doesn’t have “long term” to ride out bad times (ie, retiring now)? When does one jump off the market’s merry-go-round for good? And just how stupid would that be?
I know everyone’s answers are different, due to tolerance, needs, etc, so I will keep reading Humble Dollar and find my own comfort-level answers.
The mistake in thinking of the market as a “merry-go-round” is in thinking of it in terms of current value — what could you liquidate for today — instead of partial ownership. If you own $1 million in the S&P 500, that’s $1 million divided by $40 trillion (the total market cap) or 0.0000025% ownership.
Effectively you’re an owner of a not-insignificant share of the entire economy, so it doesn’t make a difference whether the sale price of the economy falls by 50%; you’d still own the same percentage of the US’s business activity.
You are right that it is highly dependent on an individual and their risk tolerance.
Generally, the advice given is to get more and more conservative with your investments (less stock, more stable products which might be bonds or something else) as you get closer to retirement.
As far as your question: “isn’t it possible the “always go up” situation could come to an end in the U.S./the world?”
It is possible but not likely. As long as companies can innovate and fill the needs of consumers, then the free market should always bend upward over the long run.
The only things I can see that might make this come to an end are so horrible that investments will be the least of our worries if they happen. (Global destruction via nuclear weapons, global destruction from a super volcano or an asteroid, etc.)
In the short term stocks are on a random walk. That is the reason I invest only in index funds or index ETFs. In the long term stocks always go up.
It is the volatility and the fear that it generates that makes the stock market a good place to invest. There is a huge difference between investing and gambling or there should be.
Yikes! 40% in one stock. No wonder you watch it closely; especially for 52 years.
Yeah, but I didn’t buy it. Part of compensation years ago.
It doesn’t mater how or when or at what price a stock is acquired. Once it is a part of the portfolio the only relevant value is current value.
Reinvesting dividend payments is in essence buying more shares as is receiving stock for work performed (compensation). Don’t be fooled by the form of the transaction. In both cases you are buying stock.
Thanks for clarifying all the questions I’ve had through the years. Too bad no one has offered answers! But if there were logical answers to all your questions, then everyone would be rich.
Here’s an update, my stock is down to $60.29 and nothing has changed, nothing new that wasn’t known months ago. Ah, the good news I get more shares of stock when dividends are reinvested on Sep 30, but you just know the stock price will be higher by that date. 🤑
Six months ago, they didn’t think 10-year corporates would be yielding 4.5%. If they go to 6%, then your stock will be worth $45.
True. There might not be a difference at the company, but the world around is now much different.
I have invested exclusively in individual stocks for over 30 years.
After a while, you get a feel for how the market works. As a long-term investor, you learn to take advantage of it if you get a chance. Otherwise, you just don’t worry about it – in the long run, you will make money.
The stock market is the only place where people run away when things go on sale.
As Buffet said, “it is the device for transferring money from the impatient to the patient”.
I’ve often thought “people running away from stocks when they’re on sale” is the reason the stock market has “outsized” returns compared to what you would expect from pure financial analysis.
Yes, behavioral economists have dubbed this “myopic loss aversion,” which may explain the overly large equity risk premium that we’ve seen historically.
https://www.nber.org/papers/w4369
The markets are made up of opinions. (Either human or, more expansively, human-programmed bots.)
Opinions can be aligned with you or different.
On the big dip from the Fed meeting, the consensus was that Powell’s tone and information he gave was sufficiently more hawkish than before, so the market’s reaction was to this “new” information of what the Fed is going to do in the future.
Nice article, Dick. I’ve never understood the over-reaction to missing an analyst’s target. Their numbers show tremendous precision, and dubious accuracy. When I look at my accounts now I’m also happy that steady dividends are helping stem the tide!
Enjoyed the article. Reminds me of the Buffet/Benjamin Graham quote:
“In the short-run, the stock market is a voting machine. Yet, in the long-run, it is a weighing machine.”
It is often difficult, but we investors must block out short term noise and focus on long term stock fundamentals.