Bill Roper (billroper) wrote,
Bill Roper
billroper

A Brief Primer on the Markets

Well, the Dow Jones has just dropped 10% across the last two days following the election. I heard the financial reporter on WBBM-AM this morning saying that it was because people thought that Obama would not be in office soon enough to implement his economic plan. Now, that's fascinating logic. I could equally easily say that it's because the markets recognize that Obama will soon be in office to implement his economic plan which has included things like raising the capital gains tax rate in the interest of fairness, regardless of its impact on government revenues. (That may or may not be part of his economic plan now, as these things are subject to change.)

But that would be equally specious reasoning. In the short run, it's not necessarily easy to figure out why the market is doing a particular thing, only that it is doing it and that it reflects some belief that the value of the shares traded is either higher or lower than it was before. And you need to recognize that there is a buyer and a seller in each of these transactions, so for everyone who is deciding to sell a share at a given price, there's someone else who is willing to buy it.

I used to work with a fellow named Gregg Jarrell, who had been the chief economist at the SEC. He was, in a masterpiece of timing, scheduled to give a speech the day after Black Monday back in 1987 when the stock market shed about 22% of its value in one day.

Gregg stepped to the podium and said two words: "Efficient markets."

He brought down the house.

See, here's the thing you need to remember. The markets set prices efficiently in the long run. From day to day, they're as subject to irrational behavior as, well, any one of us are as individuals. They're also subject to short run manipulation. You may have missed the story the other day where Volkswagen was briefly the largest company in the world by market capitalization. It turns out that a lot of people had shorted the stock figuring "It's an automaker. They're going down." They then got squeezed by a run up in the underlying stock and lost their shirts, because they had to be able to get shares in order to get the heck out of their short positions.

It turns out that Porsche managed to get control of enough of VW's shares that there were twice as many shares shorted as were actually available in the market. Oops. Poor short sellers.

It's not enough to be right. You've got to have enough cash to ride out those periods in the market when everyone else is convinced that you're wrong.

Take, for another example, oil prices. I frequently said that I thought that oil was unsustainably high and that I thought the natural price was somewhere around $70 a barrel. Now, admittedly we've had some really lousy economic news that's helped drive the price down, but look at where we're hanging right now. $60.77 a barrel. Down from $147 a barrel. Boy, I could have made a fortune.

If I'd only known when I was going to be right. We were never really that short on oil, but we were certainly getting squeezed. We're not that long on oil right now either, but the squeeze is done. For now.

Sure, I could have made a bet in the commodities market that oil was going down at any time. But could I make a bet that was timed correctly? Not without getting lucky.

Trying to time the market is a good way to lose money. If you sell stocks when the market is going down, you might miss the bottom of the market, which would be good. You also might miss the recovery. This is why, should you have a stack of money to invest (Right now? Have a stack of money? What'd you do, win the lottery?), the best thing to do is to invest some of it now, and some of it six months from now, and some more of it a year from now, and so on. You might miss some gains going up, but you're also unlikely to put all of it in at the top of the market, which would suck a whole lot.

In the long run, the best place to put money is into equities. This assumes that you're investing for the long run, because -- in the short run! -- you can lose a lot of money. But if you have the time to wait it out, you'll on average be better off by buying stocks than by keeping your money in the bank.

This is why investment planners tell you to reduce the amount of equities in your retirement accounts as you approach retirement age. If you're going to need the money soon, equities are not a safe place to be. You want the money in something more stable.

The risk of an investment is related (in at least one dimension) to how much the return on that investment tends to fluctuate in the short run. If you're willing to absorb more risk, you can get a higher long run return.

You just have to be sure that you can survive until the long run arrives. Because, to quote Keynes, "In the long run, we are all dead."

So if you have the chance to do so, keep putting money away in your retirement plan. And if you've got a good bit of time until you retire, put it in equities.

That's what I'm still doing. And it's what I've done with Katie and Julie's college funds.

That's my money going where my mouth is.
Tags: economics, finance, musings, politics
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