Tuesday, August 25, 2015

Stock Market Crash

I am not going to write a commentary on what is happening to the stock markets around the world. Things are happening in ways that many do not expect. But some do expect such happenings and are therefore not surprised.

What I propose to do here is to bring some clarity to thinking about the stock market in general.

1. Market Capitalisation, Market Valuation

This is probably the most exaggerated way to think about value and wealth. The market cap or valuation is just a very bad concept to use.

Say there are a 1,000 shares. The price of the last share traded is $1. The market cap is $1,000. The price of the second share traded rises to $2. The market cap is $2,000. The market value is said to have "increased by $1,000" making everybody feel richer. If the price of the third share is traded at 50 cents, then the market cap is $500 and the market is said to have "lost $1,500" in market value.

It is incredibly how people are made to think that they have created and lost wealth just by the value of one last share traded.

So in the current "red lights" markets, speculators glorified as investors are said to have lost billions of dollars around the world. Bunkum! I think people really have to work hard for a living and just punting stocks and trying to be filthy rich overnight.

2. Stock Market Is Not The Real Economy

The stock market is not engaged directly with the underlying economy of investments and workforce and transportation and sales. The stock market deals indirectly with the underlying economy by trading in the shares of companies and in raising funds for investments.

The stock market functions properly with a well-controlled financial and banking industry, with relative scarcity of funds so that stock prices will be more reflective of fundamental values of the companies.

In an economy with ease liquidity and zero interest rates, stock prices tend to be over-priced because everybody is piling into stocks for lack of better assets to keep value. This is when investors become speculators, as share prices soar way above their fundamental values.

The stock market crash is one way to reduce the excess supply of money in the system.

Unfortunately, those who do not have money may be the ones to suffer in a stock market crash while those who have money may be the ones making the money simply because it is their business and they are experts in playing the stock market.

The stock market crash is not necessarily a bad thing; it may be positively desirable.

3. When Is A Stock Market Crash Bad For The Real Economy

A stock market crash is bad for the real economy when banks have also been lending to speculators or have also been speculating in stocks themselves, so that a stock market crash immediately and directly impairs the capital base of the banks themselves.

When there is a bad loan, the bank must set aside a portion of their capital corresponding that bad loan, with a view to writing off the loan in the end should the worse comes to the worse.

When the bad loans of a bank rise very sharply, the bank may not have sufficient capital to be set aside as reserves for the bad loans. This is when a bank becomes insolvent and shareholders must pump in money to pay for the bad judgement of their lending policy. If the shareholders have not enough money, then the government may have to step in to shore up the capital of the bank. If not, the bank cannot function and it has to close down, thereby leaving depositors with only a few cents for every dollar of deposit they have left with the bank.

A stock market crash is bad for the real economy when many banks in the economy are caught by insolvency and they have to curb their lending to real businesses or are unable to function as proper banks anymore. This is when the investments in the economy fall as a whole and the economy shrinks into recession.

4. When A Stock Market Crash Is A Good Time to Buy Stocks

When we know that the banking system as a whole is still strong during a stock market crash, we know that the stock market crash is the time when share prices have fallen sharply and sometimes to way below the values of the stocks. This is the time to start buying stocks.

5. Ways To Invest In The Stock Market

(i) Identify companies that you like. Good companies are those that sell products that are always needed by consumers into the far future.

(ii) Identify the fair value of the shares of the companies you have identified in (i). You must do your homework.

(iii) Wait for share prices to fall to below the fair value of shares as identified in (ii). The only input is patience.

(iv) You must have set aside a substantial sum of capital to invest in stocks in the first place. It will be money that grows by itself as the economy grows.

(v) If you can do (iv), then you may already found a way to make and save a significant sum of money and why on earth would you then want to dabble in shares.


walla said...

I guess if everyone follows the same rules, then no one will be advantaged in a trade. If all buy at the same time because the rules say so, then who sells? If there is no sale, then there is no trade so how can bull or bear run? Hence it seems not following the same set of rules is what moves the market. Since rules must be consistent in content, they must be logical in approach so that what moves the market is illogicality. Like punting or playing the numbers to try pot luck. The antithesis are the big institutional players who construct a rationale in order to move the market or out of it in their favor even to the extent of playing the currency to mitigate their losses.

Next, why would individual people take such risks? They could be curious enough to follow the herd, or think they are privy to some special information, or are convinced they can see a pattern emerging. Underlying all this is the maslowian motivation to provide for the future by getting a pile of cash now prompted by not seeing anything attractive in hard-work investments. Which also begs the question of what is then the fair value that is be calculated and used as yardstick.

In the past and here, incentives in the west moved hot money in, and people made their piles connecting contra waves spiked by upticks on the wings of privatization and corporatization. Their wealth was created by the harmonic oscillators of the market. But those halycon days are over just as the wakeup call has finally reverberated across every facet of the economy today which is further held to ransom in a no-holds-barred political stranglehold which has made short shrift of all rules of decency.

It would be ironic if saving a political party destroys the very nation in which it is to operate but by the looks of things, that's as assured as the next fall of the ringgit.

walla said...

Most people are wage-earners. If the produce and/or service market is weak, then the economy is slow and wage-earners cannot expect security let alone increment or bonus of any size as to command enough capital to sustain a long-term play in the stock market.

Yet wage-earners are those needing extra-funds the most because what they earn cannot buy them a home or service one these days, or help them pay for increasing educational costs overseas for their children in preparation for exodus from the flood of stupidity that has spread like the plague in this land. Few can afford a holiday anymore in order to get away and recharge their batteries. Those who can will look with dismay at their dwindling savings which even if standing still will be falling in buying power what more on the back of insipid interest rates. Most will fall into the deeper holes of debts while holding onto jobs that are at best unsteady income sources.

Yet all know if governance is given primacy, then both public and private sectors can earn trust of spenders and investors so that more capital can roll in and around to spark productivity and creativity and nurse the economy back to enduring health and greater resilience. Without good governance, trust will be gone and people will only play the stock market because they can only see risks increasing in all segments of the mainstream market. The tipping point is when the long-term risks of brick-and-mortar businesses eclipse the risks from the short-term dynamics of the virtual share market and financing business so that the original remit of the stock market as non-bank lender to enterprise gets distorted permanently.

Working the hardest and most honest, the middle-income earners these days are hurting the most in the history of this country. The unfairness to them is a grievous indictment of all that has been going bad and wrong here. In a manner of speaking their working here and contributing quietly to the economy and country for all of their lives is like an investment gone sour just as the pallbearer comes a-calling. They have no reprieve nor succor for their families, only a fate written on the graffiti-ed walls in some forgettable backyard to the rest of the world. When people have to kid themselves by comparing more and more to only those lower and lower in the ranks, you know it's curtains.

walla said...