Paul Solman: This afternoon’s question comes from the steward of The Business Desk who wrote, moments ago: “I don’t know how you feel about this, but I thought maybe you could do another response to the day? The market just closed and is below 9,000 for the first time in five years.”
Her query being my command, here’s a reply:
There are said to be two different ways of looking at the stock market swoon: 1) As a verdict on the bailout/rescue plans of the moment; 2) as a grim prediction of the economy’s future.
Actually, I’d look at them as one and the same.
As a verdict on the bailout/rescue plans, the message seems to be: too little, too late. Or, perhaps: there could never have been enough, soon enough, because the world’s governments can’t prevent a deep economic downturn.
A little basic explanation of stock prices before I proceed.
Fundamentally, the price of a stock represents an estimate of value – today’s best guess as to what a company is worth. And what IS a company worth? At the very least, it is what it owns (its assets) minus what it owes (its liabilities). So, shut down the company, pay off its creditors, sell everything it owns and what’s left is its “net worth,” calculated just the way you or I would calculate ours.
But when you’re buying shares in a company, you’re betting it’s worth a lot more than that. After all, a company is supposed to make money: PROFITS. And theoretically, its stockholders GET those profits, either in the form of dividends (which is the way a company shares its profits with shareholders) or reinvestment, which will presumably make the company MORE profitable, which will make its stock more attractive to investors, who will therefore bid up the stock price.
So an investor either receives her share of the profits as dividends or as “capital gains” (via a higher stock price), or both.
Today’s value of a company then, as reflected in the stock price, is a guess about how profitable it will be in the future.
In short, today’s price is tomorrow’s profits, and tomorrow’s and tomorrow’s. Add all the stocks of the 30 major companies of the U.S., weighted by size, and you’ve got the Dow Jones Industrial Average, whose price is all their future expected profits, “discounted” to the present.
But if we’re now spiraling down into a recession or worse, tomorrow’s profits are going to be a lot lower than we’d thought, right? Same for tomorrow’s, perhaps. Lower profits, lower stock prices, lower Dow.
So the verdict on the bailouts would quite clearly seem to be: it isn’t going to revive the global economy, which means hard times and lower profits. Which is THE SAME THING as saying that investors are predicting a grim future.
There is, however, a more hopeful way of looking at this: that the world’s investors are simply running scared. They think the world’s financial authorities don’t know squat about how to fix the global economy, so they panic (understandably) and sell, sell, sell. Especially investments that are already going down, like stocks, once considered oh-so-safe “in the long run,” now understood to be as risky as they always were.
But if the authorities don’t know squat, how likely is it that INVESTORS know anything? Indeed, the one thing research consistently shows is that while we’re all told to buy low and sell high, investors tend to do just the opposite – buying when everyone else does (think Pets.com) and selling at the troughs (now?).
It’s not that investors are necessarily or reliably wrong. The Dow can always go lower. As I’ve been reminding people lately, the Dow hit a high of 380 back in 1929, plunged to 42 at the bottom in 1932, and didn’t make it back to 380 until 1954! (Late ’54.) That’s 25 years.
Similarly, if I’m reading my charts correctly, the Dow reached about 1000 in 1965 and was at the same point 20 years later, before taking off on the binge we’ve seen since.
As for Japan, don’t ask. (If you do ask, the answer is: the Nikkei 225 average is now at about 20 percent of its peak, reached almost 20 years later.)
So yes, things can get worse. And can stay worse. Much of it is a self-fulfilling prophecy: how will we all react to this predicament?
But I would remind readers that this country has the same economic resources – people, land, raw materials, technology — that we had yesterday, last week, last month, last year. In fact, we have MORE people and MORE technology. So the problem is HOW to deploy our resources. The markets, left to their own devices, have done a spectacularly poor job. So now it’s government’s turn to mobilize us so we don’t sit idle and become even less rich than we are tonight.
That will depend in large measure on whether we continue to panic. Or maybe, as a wise friend says, get tired of doing so. But whatever happens, panic shouldn’t be understood as prediction. I’ve share my motto before: There is no big time. It means that the big shots are as clueless as the rest of us. But when people panic, they’re often more clueless still.