More Sellers than Buyers?

The second quarter of 2009 has been one of the best performing quarters in the history of the S&P 500. The 14.61% return for the S&P 500 during the second quarter is the best quarterly return since 1998, despite ending the last day of the quarter down 0.85%.

As I listened to a market recap on the radio yesterday afternoon, I heard the reporter state that “there were more sellers than buyers in the markets today.” This statement is simply not true because stock markets are not like housing markets: they do not decrease in value because there are more investors selling than buying. The stock markets are more like farmer’s markets in that every day, for every transaction, there is one buyer and one seller.

The stock market is a daily example of supply and demand. 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. Every time an investor buys a security (stock, bond, mutual fund, ETF, etc), the investor is buying that security from another investor who decided to sell the security. The same works in reverse. When an investor decides to sell a security, that investor must sell it to another investor.

The reason the stock markets tumbled downward through 2008 was not because there were more sellers than buyers. It did so because investors who were selling believed their securities were ”worth” less at the time of sale than they were at their time of purchase. There are a plethora of “strategies” investors use to determine what a security is “worth”: fundamental analysis, technical analysis, dividend discount model, contstant growth rate model, two-stage dividend growth model, price-earnings ratio, and price-cash flow ratio to name just a few. But at the end of the day, the value of a security is determined by supply and demand. That is, a security is “worth” what an eager seller is willing to sell the security for and what an interested buyer is willing to pay for the security.

In simple terms, picture a game 7 of the World Series between the Cubs and the Sox. Outside Wrigley Field there are two vendors with World Series Champs t-shirts; one selling Cubs shirts and other selling the Sox shirts. At the end of the game, one of the vendors will be in control of the price because there will be a large demand (and you can be certain that the price will be high), but the other vendor will be at the mercy of the buyers. When demand is low, the buying investors have the advantage because they get to determine how low that security will be purchased for. Simply put, when supply is high, prices go down, and when supply is low, prices will go up. (We wrote a very similar post in our blog Why the Increase in the Stock Market? on May 22, 2009.)

As one of my college instructors used to say all of the time, “There are two seats for every transaction: if there is no buyer, there can be no seller.”

(Originally posted on July 1, 2009)

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