Morning Market Thoughts
Good morning. Just a couple of thoughts today.First, don’t forget to check out yesterday’s training session on methods for preparing for the holiday break. “Should I Stay or Should I Go?” It’s more than a Clash hit, it’s the question that every trader should be contemplating this time of year.
Stocks are up this morning as we go into the last two trading days before a three-day weekend. Volume tomorrow should be quite low, so don’t expect any fireworks. Jobless claims came in slightly above estimates, thought GDP is now at 3.2%, thus once again justifying Thomas Carlyle’s description of economics as “the dismal science”. When you are always confident but only occasionally correct, you’re not much better than a broken Rolex. Why do economists have such a tough time being correct? Because the science of economics is the science of understanding people. They’re not statisticians; they’re psychologists in the business of predicting the behavior of people. I don’t need to say anything more about that. When you really think about it, how can that possibly be accomplished? If it was possible to PREDICT crowd behavior, every trader would rush to get an advanced degree in economics. Rather than remain traders operating on “If,…then….” hypotheses, we’d all just be winners who were always confident, and only rarely incorrect.
We don’t need to make sense out of crowd behavior. There is no sense to be made of the value of stocks. Honestly, stocks are not much different than cryptocurrencies. The hit on cryptos is that they have no value. How many times have we heard that there is no basis for determining the “correct” price of Bitcoin (BTC)? I agree with that contention. There’s no way to value cryptocurrencies because their price is determined by the crowd. They epitomize democracy. Everybody gets a vote, and the majority wins. Every time. Seems a bit dicey to me, because crowds can get totally irrational and push prices to unsustainable extremes. But that’s what happens.
Why are stocks any different? How many times have we seen extreme moves in the price of a stock, only to watch it revert back to the mean price? The only thing that changed was the prevailing opinion of the crowd — which is exactly what governs cryptocurrency prices. Most stocks correlate with the broader market. When money is coming into the market, lots of stocks benefit because…they are part of the market. When the major averages are selling off, many stocks also decline. But during those rallies or selloffs, what has changed in the valuation of a specific stock? Is the company suddenly more profitable or less profitable? Has the company’s business fortunes changed such that there is a justification for the change in price of its stock? No! And as a shareholder, what do you get for your investment? If the stock pays a dividend, you get paid. If it doesn’t, all you’re holding is air. You have a sense of security because you can study the fundamentals of the company. You can look at the income statement, the P&L statement, and the balance sheet. So you get a sense of valuation. But that’s a false sense of security. If you’ve been trading for any period of time, you know that stocks with great fundamentals can tank, while stocks with horrible fundamentals can make strong moves. Fundamentals don’t move stocks; crowd behavior moves stocks. Over time, the fundamental picture will influence stock prices. But at any given time, they are irrelevant when compared to crowd psychology.
I’m not making the comparison between cryptocurrencies and stocks to justify any valuation in digital currencies like Bitcoin, Etherium, Litecoin, or any of the hundreds of ICO’s that are sure to hit the market. Rather, I’m making the comparison because it’s important that you realize that the biggest influence on stocks and cryptos is the same — crowd psychology. And what’s the difference between the most expensive pair of jeans and the cheapest? Assuming the quality is the same (and that’s a safe assumption in most cases), the only difference is in the style. But what makes one embroidery pattern on your butt more valuable than another? The “V” on your Levi’s has been around for generations. Is that more or less valuable than some complex pattern on a pair of “designer” jeans? No! The crowd is fickle. Fashions change. If it were otherwise, the fashion industry would cease to exist. Back in the 70’s, I was a big fan of bell bottoms (and I’ve got to tell you, I really looked good wearing a pair of bell bottoms and harness boots). But times change, and I would have a tough time even finding a pair of bell bottom jeans (assuming I would even want to search for them).
Yesterday’s treasure is tomorrow’s trash. Whether it’s stocks, cryptocurrencies, or jeans, the valuation is determined in the same way — it’s an auction. The price is determined by the crowd.
If you can recognize that valuation of different things is determined the same way, you’ll break through the false illusion that you know more than the crowd. When you start thinking that you actually KNOW something about determining the “correct” valuation of any asset, you’re no better than an economist. And those guys sound really smart, but they never make any money.
–Dan
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