I've been incorrectly bearish on the overall stock market for a few months now, which I attribute to naivety. Fundamental analysis got me interested in stocks and continues to drive my investment decisions. While fundamentals are important and concrete, they can be perceived differently and markets are well known for getting to extremes beyond justification. My general view on the U.S. economy is negative due to structural problems and for several months now I believe US stocks have traded above fair value. That said, I had no legitimate reason, until earlier this week, to think that stocks would sell off anytime soon.
Since early February the DOW has gained as steadily as a tortoise in new Nike's racing against a passed out drunk hare. Resistance has been nowhere, but that's because we've been tiptoeing so quietly. Market makers are 100% committed to making this rally look real, primarily because it's not. That commitment requires eliminating the manias that are now understood to accompany bubbles and selling the public on a quiet, easy money market.
More important than anything I've just discussed is understanding how the stock market works in terms of buyers and sellers, who are the only real forces in the market. Investment banks operate to make money and stocks exist so that business owners can raise capital for or sell stakes in their businesses. There is no reason, aside from dividends, that stocks increase in value. A growing business should enjoy appreciation in market valuation, but that's up to the market. The way I look at value investing is: I'm always the little guy, buying or selling, and I'm either trying to follow the big guy or trade against other little guys. If I buy a stock with the intention of profiting, I'm assuming to sell that stock to someone at a higher price. Expecting to sell back to the person who sold to me seems rather ignorant, so I need someone new to buy my shares later. As a little guy, it is important to understand that the big guy always wins. I can win with or without him, but I cannot win against him.
Until recently I was convinced that retail investors were as invested in equities as they could afford to be as of late last year. After a big bounce off the bottom last Spring, gains were strong and steady throughout the year with only minor setbacks. Employment and housing are going nowhere, so Joe Schmo has no reason to believe in the economy today. What he does have every reason to believe is that the government and banks are working together to prop up the stock market, which now gains .2% daily without ever blinking. Equities cost twice as much as they did a year ago, but President Obama and his printing press won't let the little guy get hurt again. Joe likes this better than the old stock market, which was like gambling. He's made some very profitable trades, but overall the market has crushed him and Joe sure does hate volatility and risk. In this new market he accepts that he won't wake up to 50% gains overnight, but if he commits enough capital to blue chips or ETFs he can rake in a nice return. Right?
We're about to find out. The trading week of April 12-16 was the wildest I've witnessed in a year. Investors piled into highly speculative stocks from cashless micro caps and biotechs to hopeless financials. Volume was equally impressive in larger companies and ETFs, in dollar terms well beyond anything we've seen in a year. I'm even convinced that retail investors were net buyers on a down Friday, as they've been hearing that a pullback would be bullish and probably forgot what one looks like.
Only time will tell to whom and at what price our friend Joe will sell.
Disclosure: None mentioned
