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When Jon Stewart talked about the “two markets” in his <a href=”http://blog.indecisionforever.com/2009/03/13/jon-stewart-and-jim-cramer-the-extended-daily-show-interview/”>interview with Jim Cramer</a>, he wasn’t completely correct. There are two markets, but they aren’t exactly the ones Stewart described (though very close).
Long term, there’s only one way a stock is going to go up, and that’s if the corporation you buy stock in makes money, thus raising the company’s value, and thus the value of your stock. There’s simply no way around it – unless a company isn’t earning a profit (including employee expenses and dividends), it’s going to be more valuable.
Short term is a different story. Wall Street traders make their money via the crazy variances in how Wall Street evaluates a company’s worth, and CNBC helps to inform those decisions. Think about it. When GM’s stock price drops 1% in a given day, it’s not because 1% of GM’s total value was stolen. It’s because Wall Street’s opinion of GM’s value has changed. Follow the jump for the implications of this.
What people figured out is that you can make a lot of money outsmarting other investors trying to evaluate a company’s worth. If you think X company has a great new product out that’s about to get some buzz, a smart trader might buy that stock so that when the buzz (and Wall Street’s speculative evaluation) changes, the trader can make money off of the change. Shorting a stock is doing the exact same thing, but in the opposite direction.
Much of this is obvious – it’s why we ban insider trading, which is based on information that has not yet been released to the public. Everyone trading is supposed to have the same information on which to make judgments about companies. However, the rise of a 24 hour news cycle and CNBC along with it have made those evaluations much more fluid.
The insane fluctuations you see every day in a given stock are just the noise of traders trying to outsmart each other by moving things around in a way smarter than the next guy. Long term, your money was supposed to be safe in certain companies that had solid, profit earning business models.
But the short term took over – and the scheme worked for year after year after year. A world where 35-1 leveraging was insane yielding to the financial reality that there was a LOT of money to make via leveraging. How? Leveraging allowed people to take bigger bets with both bigger rewards and bigger risks. But the rising market diminished those risks; traders and analysts drew greater and greater rewards for crazier and crazier schemes.
The short term speculation and need for new assets to buy and sell created a need for more assets, which came in the form of sub-prime mortgages secure only in a rising home price bubble. Everyone made solid money in the short term, and took us higher and higher until we stepped off the cliff.
And suddenly we had no more lending available, and for once, the REAL VALUE of companies dropped as credit and orders dried up. Our market of safe investments had been taken for a ride; and suddenly profits weren’t so easy, and we entered recession.
Obama’s actions will have real effects on the market’s long-term future; his taxation policies and regulations will have real effects on a bottom line. But day-to-day, it’s all speculative noise, and we should all stop calling it otherwise.