Investing Myth 2 | The Stock Market Myth | I don’t believe stock markets are sustainable.
Hi Intelligent Investor,
Have you read the first investing myth? Find the Savings Myth here.
We move to Myth 2: The Stock Market Myth: I don’t believe in Stocks
The stock market would continue to drive the creation of value in all economies. But also with the occasional bust.Click To Tweet
The Stock Market Myth: I don’t believe in buying stocks
Ask anyone who was hit by the Global Financial Crisis-GFC what they think about investing in African Stock Exchanges, e.g, the Nigerian Stock Exchange-NSE. Their reply would be something along the lines of
‘Not in a lifetime’
‘Never again as long as I have my breath’
‘Over my dead body’ etc.
Most people have gone on a sworn verdict never to ever invest in the stock markets irrespective of how profitably sustainable it gets.
But that exactly is human nature. As humans, we think in herds. It is called the herd mentality. And we only come to our senses one by one. Read Charles Mackay’ Popular delusions and madness of Crowds.
And for Stock Exchanges around the world, this dictum rings true to form.
The Stock Market: Boom to Bubble to Bust
The logic of investing in stocks follows a quite simple path.
You have had a boom that bubbles. Then eventually it bursts.
Let’s paint a scenario of six investors, Messrs A, B, C, D, E, F who are all interested in the stock of company Z.
Now, let’s see how they enter and exit the stock Z.
- Mr A buys stock Z after analysing the current conditions in the market. He is optimistic that Company’s Z stock is poised to do well over the next few months.
- Mr B, reads Mr A’s analysis and buys Stock Z, based solely on the fact that Mr A’s conclusions are plausible. Knowing that Mr A is an investment expert who has access to a credible information about the economy and stock Z.
- Mr C sees stock Z going up because Mr A & B bought it, and jumps on the bandwagon. Only because he knows Mr A and Mr B are always the first to know the trend of stock Z.
- Mr D hears the news media, the fourth estate, gyrate ferociously about stock Z that Messrs, A, B, C bought. With experts all predicting that stock Z is going to be ‘the next big thing’. No other time to enter than now. And wham, Mr D buys stock Z.
- Mr E comes the next day into the market and discovers every investor is buying stock Z except them. So based on that self-dignity, they buy stock Z.
- Mr F only hearing about stock Z for the first time believes all that everyone has said. Mr F buys stock Z because they believe and expect stock Z to continue to increase in price. They believe since Messers, A, B, C, D & E are in it, they are safe at the harbour.
Then next day after Mr F’s made a purchase, Stock Z stops going up.
In economics, when Supply is greater than demand, the price adjusts downwards.
Then Mr A goes out.
Followed by Mr B who sees Mr A’s move and follows in tandem.
And stock Z continues to go down.
And then one day, it goes up no further.
Then Mr C with reluctance takes the path of Mr A & B and gets out.
And stock Z goes down a few more points. But it recovers quickly.
And then suddenly Stock Z falls precipitously.
Suddenly, Messrs, C, D & E all want to go out.
And stock Z crashes a lot more.
While Mr F, who entered just at the top when Mr A goes holds on to stock Z.
He still believes stock Z would return back up.
And that is the story of the Stock Market Boom and Bust.
And then the cycle repeats itself again and again.
And that is the story of stock market bubbles and burst.
Let’s call Mr A – Value Investors
Mr B- Market Participants
Mr C- Great Fool
Mr D- Greater Fool
Mr E & F- Greatest Fool
The Greater Fool Theory
The greater fool theory states that the price of an object is determined not by itsintrinsic value, but rather by irrational beliefs and expectations of market participants.
The irrational beliefs and expectation of market participants (Mr C, D, E & F in our case) is what makes the greater fool work every single time.
Across nations, centuries, ethnic and gender. Every. Single. Time. It Works!
None are buying stock Z until Mr A does the analysis. When market participants (Mr B) hear that stock Z is heading up, they, the Few, jump on it. And more participants (Mr D) buy what few people bought. And most (Mr C & Mr D) people buy what more people buy. And when All (Mr F) people have bought what most people buy. It busts.
That is exactly how the stock markets work. The moment you are not buying when None and Few are buying (Mr A & Mr B), you get to enter the greater fool race.
Now if you can get in between the Few or None arc and get out before the bust angle, you stand the chance of escaping a total melt down when it does occur. And that is the secret or Holy Grail of Stock Exchanges.
The Engine Room of the Economy
But as long as the earth remains, the Stock market would always be the primary tool that businesses raise capital and the participants buy into their worth. When businesses are doing well, they either raise debt through banks or equity through the stock exchanges.
Equity is cheaper because shareholders, stock owners, own part of the company and share in the risk of the business, up or down.
Because the company is listed on a stock exchange, anyone can trade the shares based on perceived value (rumour) on the company.
This speaks to the reason why stocks fluctuate in value wildly while the company has sound business fundamentals.
Wise investors of the intelligent type would invest in a company’s stock based on its fundamentals. And that alone would guide the decision to sell or buy. Not and Never should beliefs and Expectations guide your investments. The only thing that counts is intrinsic value.
But really as long as the earth remains, market bubbles would always bust and people would lose funds.
Your job as an Intelligent Investor is to ensure you based on value and never on sentiment.
Sounds simple? Well yes until you gice it a go!
Until the next myth…Save|Invest|CompoundWealth
5 min read.