The Market is Oversold

FILE- In this Tuesday, Oct. 23, 2018, photo specialist John Parisi works at his post on the floor of the New York Stock Exchange. A period of relative calm on Wall Street that led to a milestone-setting September for the stock market came to a sudden, screeching halt in October. The slide snapped a six-month winning streak for the benchmark S

Stocks are down this week.  Actually, they are down this month, and by a lot.  We are down ~25% from where we were on Feb 19th.  Some portion of this drop is from the Wuhan Virus/Coronavirus/CV-19 (personally I don’t really care about the name).  Some portion of this is that over an 11 year bull market we probably overvalued stocks.  However…

What is a stock worth?  When you buy a stock you are buying a small portion of a company.  That portion has value only insomuch as you can sell the companies assets, or insomuch as the company is going to make money in the future.  So Exxon is valuable for their money in the bank,  the gasoline they have in storage (which can be sold to consumers), oil they have in storage (which can be sold to refiners), equipment they own (which can be sold to competitors), and for all the money you think they will make in the future.  When Exxon stock goes down it isn’t usually because they wake up with less money in the bank, or their storage tanks leaked all their oil.  What happens is that investors believe they will earn less money in the future.  This could be because Saudi Arabia and Russia have decided to sell as much oil as they possibly can driving down the price of oil.  It could be because Tesla makes an amazing car and investors think future drivers won’t need gasoline.  It could also be because investors believe there will be a recession and people will drive less.  It could be because we find out that Exxon has committed fraud (or not-quite fraud) and they now owe somebody $50 Billion.  For any company the reasons for a drop are numerous.

However, if the whole market is down that is because investors as a whole believe the economy will produce fewer goods/services in the future than they used to think.  That is like saying “well, Exxon is going to pump 25% less oil, and GM will make 25% fewer cars, and iTunes will sell 25% fewer songs, and Facebook will sell 25% fewer ads, and…” through the whole economy.  It very well may be true that GM will sell 25% fewer cars this quarter than they otherwise would have.  It may even be the case that they will sell 25% fewer cars this year than they would have if coronavirus never hit.  However, do you think it is a reasonable assumption that they will sell 25% fewer cars in 2025 than they would have without coronavirus?  How about Netflix, will they have 25% fewer subscriptions in 2025 than if coronavirus never hit?  Probably not the case.

Well then, maybe it is the case that we just overbuilt the market.  Possible.  However, if you look back we are now down below the market level of November 2017.  To say that we overbuilt would say that 75% of all the gains since Trump’s innaguration were illusory.  That would imply the tax cuts, the job growth, the wage growth, the cuts in regulations, all the positives over the last 3 years were overvalued by a factor of three.

So what is reality?  Reality is that coronavirus is going to have an effect on our economy.  However people will still eat, drive, buy stuff, and generally live their lives.  The coronavirus will eventually pass, and when it does our economy will continue as it did before.  If the economic hit is $1T, and is borne only by stock prices then stocks should lose 2% of their value.  If we were just due for a correction then stocks probably should have lost ~10%.

What can account for a 25% drop when a 10% drop should have sufficied?  Well, people sell even after the appropriate correction has taken place.  What would that look like…

  1. The stocks of a few companies that are tied to supply lines in Wuhan province drop.
  2. Then linked companies drop.
  3. Traders see this as an overall correction and sell out of stocks that they had been speculating on in order to capture profit before they lose too much money.  Additionally leveraged traders sell in order to limit losses.
  4. The news anchors then start ranting for hours every day about how much money everyone is losing and how 401k’s are being decimated.
  5. Now the average 401k owner starts moving some of their stocks into bonds pushing the market further down.

This sixth group is not formed of informed investors.  These people are selling based on panic, and the informed investors are the ones in the market right now buying what the retiree is selling.  By the end of the year the virus will have run its course in Asia, Europe, and the US.  Companies will have gotten back to manufacturing the same goods they had been making, and corporations will announce 2021 projections that look completely normal.  The traders who bought stocks from retirees will make billions of dollars, and bond prices will drop as those are sold off.  When the bond prices drop the 401k investor will be hit a second time (right now when they fled stocks, then in the future when their bond prices sink).

Markets go up, markets go down.  Sometimes a little, sometimes a lot.  Panicking and following the herd is an excellent way to lose all your money.