Will The Stock Market Return To ‘Normal’ | TimeTestedNews

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On the flip side, we often hear statements like “the stock market is highly overvalued and is attractive for a crash” or “the stock market will soon go back to normal”.How true/likely are these statements?Let’s back up a second and remind ourselves of what we know/have been told about the stock market. The stock market is a barometer of how well the economy is performing.

That is, if the stock market is growing, the economy should be growing. We have found that this is largely untrue. As the US stock market has grown significantly over the last few decades; while the average GDP and income growth has been meagre. More so, the last year has been a large indicator of this. While unemployment has been at record highs, the economy has been closed (somewhat), and people have reduced spending; the stock prices have kept climbing to record highs. This has led more people to chant the popular statement “stocks are overpriced” “the market will crash soon; get out now.” Stocks can be rightly priced when someone says a stock is over or underpriced, it implies that there is a right price for stocks and a precise valuation of a company. Is this the case? I tend to disagree.

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Here’s why:

If you monitor stock news around any stock of your choosing, you will likely get info along these lines “JP Morgan has announced a price target of $80 for this stock, Charles Schwab has announced a price target of $65 while another company announces a different target”. Every analyst or person’s valuation of a company is primarily based on the assumptions they made, using the data they have, and their imagination of the future. If there is one thing that 2020 has taught us (if you didn’t know this already), no one can reliably and precisely predict the future.

While it should be easier to estimate the “right” share price for a “mature” company like Coca Cola, we know that mature companies can innovate, they can explore new frontiers and grow further than expected. It’s a lot more difficult to estimate the right price for a company like Tesla or a biotech company like Moderna. How do you rightly estimate their market share? How do you predict the time it would take for disruption? You simply can’t. When you buy a stock that doesn’t pay dividends, you are buying into the idea that someone in the future will buy that stock from you at a higher price

Why has the stock market been climbing?

My top 2 bets are tech stocks and speculation. When people say the US stock market is climbing, they usually mean 3 main indices: The S&P 500, the Dow Jones Industrial Average and the NASDAQ. They mean that these indices, which track the performance of some companies within the stock market, are improving. However, if you look at some individual stocks, you’ll find that not all stocks are back to where they were pre-pandemic. There are, in fact, some stocks that if you had bought in Feb 2020 and not done anything, you would be losing money today. However, “the stock market is improving”.

Earlier on, (i.e. mid to late last year), this improvement was hugely driven by tech stocks that were seeing significant boosts after the stimulus package was approved and people were staying at home and spending more on tech. More recently, sectors like the energy sector have seen much boost due to the increase in oil prices. So, that could be a driver.

The more significant driver, however, is speculation. The stock market is driven not just by an event’s occurrence but the belief that the event is likely to happen. Speculation around the passing of the stimulus bill, legalization of marijuana, the opening of the economy, winner of the US presidential and senatorial elections and all of that have been some key drivers of the stock market in the last year.

Does this mean that the market is no longer running on fundamentals?

Some would argue that the stock market never ran on fundamentals. If enough people believe a thing is going to happen and likely act on it, it is very likely that it will. The stock market ran on belief. If enough people believe that there is a possibility of a huge payout, they are willing to invest in risky ideas. If enough people think a company will fail and short sell the stock, the company likely will. Except they are foiled by Redditors, of course, 😏 as in the case of Gamestop.

The major difference now, I think, is who is having access to trade/invest in markets.

Before now, access to stock market investing has been limited to more skilled personnel, stockbrokers, investment managers etc., people who can & do technical and fundamental analysis before trading/investing. The few retail investors who don’t have access to this technical information; often rely on investment advisers and managers, brokerages, pension funds etc., to make decisions on their behalf.

The growth of access to the stock market has changed massively over the last few years. With the advent of retail trading apps like Robinhood, eToro, WeBull and several others across the world, retail investors like you and me now access to stocks that we previously would not have.

Alongside access to retail trading came access to copy trading and social trading both within and outside the trading platforms. Not only can retail investors/traders buy/trade shares, they can now talk to each other about which shares they’re most interested in. Thus making it possible for them to believe that a company’s share will go up, convince other people to share the same belief and act on it, repeat the cycle long enough for it to become a self-fulfilling prophecy.

It is important to note that retail investors do not act in a vacuum. It’s not a case of retail traders vs institutions. The retail trading apps that charge no fees are very likely selling the data of the trades that their users are making to institution(s). These institutions, in turn, can choose to take trading positions that reflect the majority belief.

Even if the stock market was never running on fundamentals, we know that we have never seen the kind of single share pump and dumps of companies as we did with Gamestop, AMC, and so on. So this is still abnormal. How do we return to the slow and steady, yet volatile, stock market we’ve come to know.

How can the stock market return to “normal”?

I’d argue that we’re way past that at this point. There’s no going back to where we were pre-COVID. While I don’t also see the frenzy around the stock market remaining as it is today, we’re likely to still see the traces of that euphoria as time goes on.

Will the stock market crash happen

If you say everyday that “it’s going to rain today” one day, you’ll eventually be right. If someone says every day for their lifetime that a stock market crash is coming “soon”, one day, they are going to be right. Some Economists have “predicted” an impending stock market crash since 2014, and till today, we are yet to get reportage of the kind of stock market crash they describe.

It is wishful thinking to believe that stock prices will continue increasing for years on end without ever dropping. But, even stock market crashes offer excellent buying opportunities for investors who have spare cash and are patient. When you hear about a potential stock market crash, don’t panic. Prepare for it.

How can you prepare?

  1. Have an emergency fund. This is a savings of 3-6 months of your total monthly expenses. This will give you some breathing room if your income source is cut off. This way, you don’t have to sell off your investments at a loss because you need cash.
  2. Diversify your investments—both within and outside the stock market. Invest in different asset classes. Consider investing in other things within and outside the stock market. Also, consider investing in different industries such that if tech stocks get hit hard, for example, your investment in FMCG companies can keep you afloat.
  3. Buy the dip and have diamond hands. Trust and patience are the rules of the investment game. Trust your investment because you did your due diligence and believe you made the best choice you could make with the information you had at your disposal. Don’t panic sell because you see the price drop significantly. Be patient and buy more to reduce the average cost of your investment. Check out this article on how to do this. One sure thing is that the bull run that comes after “stock market crashes” is worth the wait. Especially if you bought more and reduced your average cost

Final Thoughts

Like our work lives and everyday lives after COVID, I don’t believe there is a normal for us to return to. While I don’t think that the stock market will remain like this, moving from one frenzy to another, it is unlikely that the market would move back to “business as usual” pre-COVID. Retail investors have realized a power they never knew they had. That’s a genie I don’t think will be going back into its bottle. Sure, I believe we are due for some regulations; what this would look like remains to be seen.

My recommendations

Strap in, enjoy the ride and stick to what you know that works. Because one thing that has remained the same is, while there has been pump and dump companies, the stable, well to do companies with “good fundamentals” have continued to hold their own. Surely, those companies won’t make you Gamestop or Bitcoin rich in a few months, but they will preserve your wealth in the long run.