Thursday, March 8, 2018

How Bubbles Bootstrap Themselves

If you tell people a stock is going to go up, odds are, it will go up, as people will go out and buy it in response to your telling them it is going up.   But that doesn't mean the stock was actually worth more....

An interesting news tidbit today - financial advisers are reporting that in "Trump Country" folks are buying stocks like mad.   Many people are opening up trading accounts for the first time, while others are pouring more money into their existing accounts.   Of course, by "pouring" we mean a few grand at most.   But multiply this by a few million people and it adds up to a lot of money going into the market.

Why are folks doing this?   It is like any other bubble or pump-n-dump scheme.   They believe the market will go up because, well, Trump.   After all, his economic genius is at work here, and he will turn around the economy by slapping trade tariffs on our trading partners, right?   After all, the CEO of United States Steel has already promised a whopping 500 jobs will be added as a result of these tariffs!  It's working!

Well, maybe.  To put that job boost in perspective, Amazon announced last year they are adding 100,000 jobs in the next year or so - full-time jobs, too.   500 new employees sounds great, until you consider that United States Steel already employs 29,800 people.  500 is a drop in the bucket.  Trade wars may benefit a few people.   500 to be exact - in a nation of 330 million folks.

But getting back to markets, what people fail to realize about stocks is that the price of a stock is often meaningless.  It is what "the last guy in" paid for his shares, and that price is based on supply and demand, not on an inherent value of the company.  Granted, over time, most stocks track company value, as the vast majority of buyers are logical (or we hope they are) and they look at things like dividend ratios, P/E ratios, profit and loss statements, and annual reports and try to divine what is a rational price for the stock in question.

But at times, stocks can over-shoot their value price, or under-shoot, and in such situations, a few wily people can make a quick buck.  Those wily people are not you and me.   The classic example is the teenager in New Jersey who, years ago, bought an e-mail list and sent out broadcast e-mails hyping various penny stocks that are sold "over the counter" on the NASDAQ.   These were stocks that were going nowhere, but had technical sounding names, or names that were similar to stocks that were going places.   You send out a few million e-mails - or tens of millions - and maybe a few hundred or even a few thousand people buy the stock.   That is more stock bought in a few days than in the history of that stock.   So the price goes from a buck-a-share to maybe three-bucks.

And for a brief moment, you think, "Gee, I made a good investment, because it is already going up in value!"

Which is akin to the feeling you get when you jump off the Empire State building.   For a brief moment you think, "Gee, I can really fly, just like those guys in The Matrix!"  But then reality kicks in, big time.   Splat!

Same thing happens to the penny stocks.   Once the euphoria is over and the teenager in New Jersey cashes out, the stock plummets and goes back to its rational price of a buck-a-share.  This is not investing, it is just gambling.   And in some folks' mind, it is basically stealing - which is why the SEC investigated this kid and fined him.   But as far as I know, he is still in business - or someone just like him is doing pretty much the same thing.

And actually, the "legitimate" market is full of this sort of nonsense, particularly these days.   Companies with no connection with Bitcoin, such as the Long Island Iced Tea Company, Kodak (remember them?) and something called "The Vapor Group" are putting out press releases that they are getting into blockchain - and watching their stock prices soar!   And people are buying anything with the word "crypto" or "block chain" in it, because, well, it's the next big thing! 

The same may be true with the current market - at least in some aspects.   Little people are buying in, and driving up prices - beyond the level of a logical and reasonable valuation by the market.   The bigger players are seeing this and selling out in dribs and drabs and profit-taking.   But long-term, it cannot be sustained.  Euphoria does not a market make.

Sadly, this underlines the problem with an investor-based economy.  Since the inception of the IRA and 401(k) in 1978, more and more "little people" are getting into the market, often not by choice.  The smarter ones realize they are not smart, and put their money into mutual funds and basically ignore it.   The dumber ones think they are smart - and can outsmart the market - and throw money at whatever Jim Cramer is screaming about this week.   They lose their shirts.   They also can bring down entire markets when they panic.