Why Are We So Enamored With The Stock Market?

"It's only when the tide goes out that you learn who's been swimming naked." - Warren Buffet

In the United States in circa 1640 Wall Street and the surrounding area was a place where local merchants and traders would gather to buy and sell shares and bonds.  Over time they divided themselves into two classes—auctioneers and dealers.  In the late 18th century, there was a buttonwood tree at the foot of Wall Street under which traders and speculators would gather to trade securities. In 1792, traders formalized their association with the Buttonwood Agreement which was the origin of the New York Stock Exchange.  The idea of the agreement was to make the market more "structured" and "without the manipulative auctions". Persons signing the agreement agreed to charge each other a standard commission rate; persons not signing could still participate but would be charged a higher commission for dealing.  Since then the stock market has blossomed and now markets across the United States trade more than 2.5 billion shares a day.

The premise behind the stock market is a place for companies to gain access to capital.  There are only two ways in which a company can gain capital; adding debt or selling equity.  There are a myriad of methods tied into these two basic principles but essentially those are the only two possible ways.  The stock market is a place where entrepreneurs can sell a portion of their equity in order to take some of their personal risk off the table or increase their capital base to expand their business.  Furthermore equity can be used as financing to acquire companies.  For this reason companies have a desire to find a liquid market that can provide them funds quickly, cheaply and easily.

Investors buy this stock for the purpose of profiting from the investment.  Buy the stock at a low price and sell it at a higher price and the spread is profit.  For these reasons they want a liquid market that provides them a sense of security by imposing stringent rules on the issuers.  These rules try to protect the investors against fraud and other forms of trickery.  Entrepreneurs that bend or break the rules are liable for their actions and can have their shares suspended or even serve a prison sentence. 

In the past the idea was to buy a stock that you believe in and hold it for an extended period of time.  Over time with the growth of the company the price of the stock would appreciate resulting in a profit for the buyer.  In addition many stocks paid a good dividend so the holder of the stock was rewarded for his or her patience with dividend payments.  If you could select the best companies you could make a fortune. 

The word FORTUNE is the often the route cause of most investors' problems.  Think of a gold rush or the mania associated with any other opportunity to garner a fortune and you get the idea.  With the advent of the Internet amateurs and professionals alike could speculate in the market and make a fortune out of betting on a stock.  This speculation or gambling was enhanced with the advent of derivatives that allowed small investors to increase the size of their bets while risking only a fraction of the collateral.  Never before has this speculation been more rife than the current market.  As the market languishes near the neutral line for the past decade, trading volumes have tripled.  With the advent of cheap powerful computers trading has turned into a frenzy where milliseconds mean the difference between large profits and losses.

Into this frenzy come thousands of amateurs most of whom trade stocks that they know little to nothing about.  They are driven like sheep to the slaughter by the incessant promotion of the markets on television in the newspapers and through the armies of stock sales people.  They are blinded to the fact that the stock market has been a terrible place to invest for the past decade. The pitch is that you should always be in stocks as that is the place where fortune's are made. However no-one mentions that fortunes are also lost there every day. Our ego gets the better of us and forces us back to the well time and time again just so we can have some bragging rights at the water cooler or so that we do not feel left behind. 

Take a favorite stock of almost every amateur investor Apple for example.  Most people believe that they know all about Apple.  They buy its products and believe that the company is bullet proof, but most of them have no idea about who the company's competitors are and how their technologies could strip Apple of its luster.  In fact most investors do not even know the name of the current company CEO, but they believe that they know the company because they buy the products.  It is a speculative investment based on flawed analysis.  However what they do have on their side at present is that the euphoria surrounding the company has driven people in their thousands to buy the stock and drive it higher.  What people forget is that Apple once was a high flyer but its product insulation almost caused its total demise until Mr. Jobs stepped back into the breach and turned the business around.  As he is now dead there is no reason why the current product offering could not be undermined by other competitors.  Just look at what Apple did to Research in Motion the maker of the Blackberry.

Take your head out of the sand and look at what the driving forces are behind stock gains - the global economy.  See where that is headed and this will give you a better understanding why I believe that the stock market may not be the best place in which to invest at present.  Companies rely on global growth in order to grow.  If there is no growth then while the toughest companies will survive it will be at the expense of the rest.  This is our current environment.  If you hold a basket of stocks and some companies make a lot of money and their share prices increase but the majority either sink or struggle then overall you are losing.  Rather take your pride and bury it and wait for there to be a signal that the global economic engine has fired back up.  Once that has happened then get back into the market.

Certainly the market is forward looking, but believe me, having been in the market for decades I know that while it looks forward, there is enough speculation in it to provide you plenty of opportunity to reinvest once things start to turn.  Even missing the first year of the next secular bull market will not have an impact if you capture the rest of a ten year move AND you have not suffered the losses that everyone else did during the downturn.  Protect yourself now and wait for a clear signal before you return to the stock market.