We hear all the time about the market. The market is forward looking, the market is volatile, the market is up or down. But what is the market? The value of Apple shouldn’t go up or down based on an event elsewhere that has nothing to do with Apple products, but the market is so powerful that it can influence share prices around the world.
If we go back in time, a market was where people met to exchange goods and services, with someone buying and someone selling. Stock markets are the same and just like ordinary markets, they have evolved over time. They used to be a physical marketplace like the New York Stock Exchange but now it takes place over computers.
It is one busy market though with an average of 7.22 billion shares traded daily last year.
With so many trades being placed every day, there are millions of individual decisions made each day on whether to buy or sell stock. The decision to do so may be influenced by the current price of the stock, a new product it has launched, political events, economic conditions.
Most of those decisions are made by institutional investors, such as pension funds and stock brokers, which is what you want. You want trained professionals making objective decisions on whether to buy or sell a stock. In the US, institutional investors make up for two thirds of the stock market and it would be similar numbers in most open economies. A pension fund takes in money from thousands of investors every day and the fund manager pools all that money before placing the trades.
Even if a fund manager believes that a certain position is strong, the fund mandate may dictate that the volatility of the fund remains under a certain level. If others are selling off, it may effect market volatility and the fund manager may have to sell too. Contagion has a huge influence on the market as others are afraid of not doing anything while others are taking cover. A real case of FOMO.
This simple rule of economics has a massive influence on the valuation of stock. We are seeing that at the moment with the massive valuations of companies. Investors are willing to pay a higher price to own certain stock even if the numbers say otherwise. Take Tesla for example. Tesla is barely profitable and produces just 2% of the global revenue for the auto industry. Yet their valuation makes up 44% of the entire value of the auto market. Their share price is up 873% in the last year!! It doesn’t make sense that a companies valuation is that high. They have a higher valuation than Walmart and 10% of the net income. But people want to hold Tesla stock in their portfolio so they will pay a higher premium to do so even if the fundamentals don’t make sense.
We like to look at how a fund or stock has performed in the past and a lot of decisions are based on these historic figures. Those gains (or losses) have happened and you aren’t going to get them again. The market is constantly looking forward to the next opportunity. The market tries to predict what the future will look like and buy positions based on that. That is why it is no good in buying stock when you read news about a company in the newspaper. Those who invest in the market already knew that through their research and the stock price already reflects the news you are only ready today.
So when you hear what the market is doing, is the decision of people all around the world making decisions based on certain events.
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07 December 2020