Stocks Market Behavior

The stocks market consists of everyone who is "in the market" and stocks price reflected their hopes, fears, knowledge, optimism, and greed of the participants.

All price movements have one thing in common: They are a reflection of the trend in the hopes, fears, knowledge, optimism, and greed of market participants. The sum total of these emotions is expressed in the price level, which is, as Garfield Drew noted, "never what they [stocks] are worth, but what people think they are worth."

The stocks market consists of everyone who is "in the market" buying or selling shares at a given moment, plus everyone who is not "in the market," but might be if conditions were right. In this sense, the stocks market is potentially everyone with any personal savings.

It is this broad base of participation and potential participation that gives the market its strength as an economic indicator and as an allocation of scarce capital. Movements in and out of a stocks, or in and out of the market, are made on the margin as each investor digests new information. This allows the market to incorporate all available information in a way that no one person could hope to. Since its judgments are the consensus of nearly everyone, it tends to outperform any single person or group.

The market measures the after-tax profits of all the companies whose shares are listed in the market, and it measures these cumulative profits so far into the future one might as well say the horizon is infinite. This cumulative mass of after-tax profits is then, as the economists will say, "discounted back to present value" by the market.

This future flow of earnings will ultimately be affected by business conditions everywhere on earth. Little bits of information are constantly flowing into the market from around the world as well as throughout the United States, and the market is much more efficient in reflecting these bits of news than are government statisticians. The market relates this information to how much American business can earn in the future. Roughly speaking, the general level of the market is the present value of the capital stocks of the U.S.

This implies that investors and traders are looking ahead and taking action so that they can liquidate at a higher price when the anticipated news or development actually takes place. If expectations concerning the development are better or worse than originally thought, then investors sell either sooner or later through the market mechanism, depending on the particular circumstances. Thus, the familiar maxim sell on good news applies on when the good news is right on or below the market's (that is, the investors') expectations. If the news is good, but not as favorable as expected, a quick reassessment will take place, and the market (other things being equal) will fall. If the news is better than anticipated, the possibilities are obviously more favorable. The reverse will, of course, be true in a declining market. This process explains the paradox of equity markets peaking when economic conditions are strong, and forming a bottom when the outlook is most gloomy.

The reaction of any market to news events can be most instructive because if the market, as reflected by price, ignores supposedly bullish news and sells off, it is certain that the event was well discounted, that is, already built into the price mechanism, and the reaction should therefore be viewed bearishly. If a market reacts more favorably to bad news than might be expected, this in turn should be interpreted as a positive sign.