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How to explain today’s crazy stock market to people

November 16, 2020

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If you think you know how stocks are doing, better check again in five minutes. The year’s been unpredictable.

One of the questions I have periodically been fielding is why the stock market doesn’t reflect the larger economic reality of people. An apt bit of curiosity and something that business reporters should be able to answer. Not just for the friend, acquaintance, or social media connection, but for readers.

With better insight, individuals have a chance to make better investment decisions, understand the world around them, and grasp fundamental issues in their roles as citizens. Here are some points that might help.

Stock indexes don’t show the full market picture

Knowing about the S&P 500, Dow Jones Industrial Average, Nasdaq, or even small- to mid-cap Russell 2000 doesn’t tell you how stocks are performing overall.

Each index is a compendium of the values of a specific set of stocks the index creator or manager has identified. But the stocks are not seen as equal. Typically, each stock receives a weight, often based on market size. What happens in the stocks with the highest weights has an outsized affect on the index’s value.

As an example, the top 10 weighted stocks in the S&P 500—including Amazon, Apple, Microsoft, Facebook, Exxon, Google, and other giants—comprise more than 20% of the entire index’s value. If they do well, everything looks as though it is. But as of the week ending September 25, 2020, the stock prices of about 61% of the S&P 500 were up a positive percent, ranging from virtually unchanged to 76%. That means the other 39% of shares were down for the year up to the biggest drop of 121.5%.

This sort of split between winners and losers is historically true and there’s virtually no way to tell which shares will gain the most in percentage.

Investors don’t care about the present

The reason investors buy any stock is with an eye to the future value of a company. If it rises over time, the investor makes money. If it falls, there’s a loss. Whatever happened last quarter or last year or even the last five minutes doesn’t matter much so long as the investor is convinced that the stock will be worth more.

What drives the anticipated stock price can be a mysterious thing. For some companies, the expectation will be for higher earnings, which is how shareholders measure their portion of corporate profits (although it’s not as though anyone is cutting them a check for that amount). For younger companies, especially in tech, growth may be key. Future losses might not matter for now if the customer base and revenues continue to rise.

If the economy is in a slump but people are fairly certain a stock’s price will continue on an upward trajectory, the share price will continue to rise.

Monetary theory

The decisions of central banks are far more important to markets than what major politicians do. Low interest rates 2008, as central banks around the world tried unsuccessfully to stimulate growth to get out of the Great Recession, do two things: make bonds less attractive (less interest means less profitability), and drive up stock prices as people looking for profit push more and more money into the equity markets.

So long as interest rates stay low and investors don’t get overly spooked by economic conditions, chances are that stock prices, on the whole, will keep climbing. There’s no where else for the money to go, and money, in this case, is equivalent to demand. The more money going in, the higher prices rise.

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