Why the Increase in the Stock Market?

For quite some time, the question asked by most investors was: “Why does the stock market keep going down?”  But now, the question that’s being asked is: “Why does the stock market keep going up?”  When we consider some recent headlines, the rise in the market may not seem to make any sense.

“Worries Over Persistent Job Losses Pound Stocks” Chicago Sun Times, May 21, 2009

“Economy: In the Eye of the Hurricane” FinancialSense.com, March 19, 2009

“Neither the Economy Nor the Stock Market Is Out of the Woods Yet” DailyMarkets.com, May 20, 2009

“Despite Retail Rally, Consumers Are Still ‘Scared’” USA Today, May 21, 2009

Since the 9th of March, a vast majority of investors have been asking the simple question of “why?”  Why are the markets going up?  There are no fundamental reasons why the S&P 500 should be up 30.07%, so many are left in wonder, arguing this point.

As an informed investor, you may be asking yourself if we have “seen the bottom?”  Our only answer to you can be, “only time will tell.”  Is it possible that the United States, as we once knew it, is forever changed as a country and will never be the same?  Yes, it is possible.  However, whatever the speculation might be regarding the country’s future, solace can be attained in understanding what the evidence of the capital markets points us to:

1. Global diversification is the key to investing success.
2. No one can predict, with consistent accuracy, when the “time is right” to get in to or out of the stock market.
3. There are specific premiums associated with the stock market.
   1. Over time, stocks provide greater return than bonds.
   2. Over time, small companies provide greater returns.
   3. Over time, value companies provide greater returns than growth companies.
4. The premiums listed above are unpredictable and can be very volatile at times.  They do not follow any specific patterns.
5. The premiums also come and go quickly, with intensity, as we have seen in both the “Panic of 2008″ and the upward trend since March 9^th, 2009.
6. There is no way to time these premiums.
7. Short-term performance can have a huge impact on the long-term performance of an investment or portfolio.

Some, so-called “experts,” have noisily predicted that we are heading for another Great Depression.  On the other hand, some are claiming that there are “green shoots,” or new growth, coming out of the soil of the country’s economy, and things are getting better based on the simple fact that the economy is getting worse at a much slower place than before.  These noisy “experts” point to valuations, price-to-earnings ratios, moving averages, fundamental analyses, technical analyses, feelings in their toes, and whatever other “reasons” they believe what they believe.

Regardless of what those noisy “experts” are saying, the value of an item has always been a merger of what someone is willing to sell the item for and what someone else is willing to pay for it.  It is one of those constants in life.  It is a basic economic principle that does not change, and most know this as the law of supply and demand.

With the stock market, for every investor that buys an investment, there is another investor that sells an investment.  There is no “great pool of stocks” where an investor can buy or sell stocks…where they would draw a bucket out when buying or dump a bucket in when selling.  For every purchase or sale of an investment, which is the trade, there are always two entities involved: a buyer and a seller.

This concept is very similar to that of buying or selling a house.  There is a buyer and a seller for every transaction.  And, just like the stock market, there are negotiations to determine what the right price is.  That is, it must be determined what the buyer is willing to pay and what the seller is willing to take.

So, what is fueling the most recent rally?  It could be any number of things, like an increase in consumer confidence, or an increase in the level of risk investors are willing to take on.  It could be changes in mark to market accounting practices (Want to see a 25% jump in the stock markets?), or that prices are historically low.  Regardless of what the exact answer is, most investors do believe that a “financial Armageddon” has been averted.  It could be all of these and it could be none of these.  Different investors have different theories, but at the end of the day, it gets down to the fact that sellers have been asking for more and buyers have been willing to pay more.  That’s why the stock markets have increased in value since March 9, 2009.

What should an investor do?

• 1. Invest for the future, not the present
• 2. Diversify
• 3. Be patient

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