It's a theme that Andrewk4 remarked on some time back. The big players simply nudge the markets around to take money of the small guys.
DYNAMIC MARKET THEORY by J. Christoph Amberger
Something has changed in the stock market. That 'something,' of course, is the dollar amount of Federal Reserve repurchase agreements, which has dropped considerably.
There is a strong correlation between repurchase activity and the current rally in stocks: In the second week of August, the Fed's repurchase activity totaled US$48 billion. A week later, the total is was 'only' US$35.25 billion. (Which means that for a mere US$83 billion, you, too, can create a 100-point rally in the Nasdaq.)
The question is: How long will this go on? How long will the Fed continue to feed the stock market's addiction to liquidity? I think the answer is simple - 2,000 and 10,000... as in Nasdaq 2000 and Dow 10,000. Those are big, round numbers that will scream, "the economy is OK!" to the American people.
But is it OK? Or is this rally based on a false idea of value?
The traditional measures of value for investors all have to do with the actual or potential earnings of a company. What is it producing? What are its costs of production? What is its position in the marketplace? What is its competition? What is its future potential for earnings?
Oddly enough, few investors these days seem to care about value any more. They didn't back in 1999 (when all they wanted was an Internet-related business plan scribbled on a cocktail napkin). And unless they're seeing sales and earnings increases in U.S. companies where we can't find them, they still don't care now. But maybe you don't have to care about value to make money. In fact, based on Taipan's research into Dynamic Market Theory, the traditional views on value are all wrong. I'll get to Dynamic Market Theory in just a minute, but first, let me explain our view of value.
We believe most market theories all deal with the 'intrinsic' value of stocks or other commodities. In other words, the notion that the value comes from within the thing. That it has value by and in itself, regardless of any associations with other things.
But we believe that, for investors, the only value of any importance is the value that someone else places on a stock or investment at any given point in time. Following this idea, there is really no such thing as a 'bubble.' If the price of a commodity like real estate, tulip bulbs or Internet stocks rises to hyper-value based on demand... then that is its true value at that moment in time.
You see, a 'bubble' is an argument about value - mostly made in retrospect, after a particular investment fad has gone bust. Investment fads that don't go bust, conversely, are called 'strokes of genius,' even if the underlying speculative analysis and risks are the same for both.
For example, at the market peak in early 2000, it was said that the stock market had a valuation of US$17 trillion dollars. That amount had dipped to US$8.5 trillion by October 2000. Right now, the valuation of the stock market is about US$10 trillion. But all these figures are assignments of value based only on what a small percentage of shares is trading for.
Only a tiny fraction of a given company's shares are in trade at a given time. Take Microsoft, for example. There are almost 11 billion shares of Microsoft outstanding, but on any one day, only 25 or 30 million might change hands. If you dumped all 11 billion shares on the market at one time, the price would plummet because of the monstrous excess in supply - no matter what was going on at the company or in the stock market. So the 'valuation' commonly given to any or all stocks is arbitrary, not real, even if it is based on the latest sale of a few shares of the stock.
Those subscribing to a bearish view of the market like to say that around US$8.5 trillion dollars of equity valuation was 'destroyed' in the bear market from early 2000 to October of that year. But since valuations are assigned arbitrarily anyway, they can't be destroyed. They change up, they change down. But they never go away. And that US$8.5 trillion wasn't 'created,' but was generated by the reallocation of savings and spending money put into stocks, which pushed share prices up overall, causing the higher 'valuation.'
And here's another interesting little fact: In 1982, at the beginning of the last 'bull market,' there were only about 1,500 companies listed on the New York Stock Exchange, with roughly 40 billion shares. The market valuation was around US$1.3 trillion.
But by the year 2000 and the end of the bull market, there were over 3,000 companies listed on the New York Stock Exchange... with over 349 billion shares available. Granted, some of these were start-ups, but it's obvious that a lot of the 'wealth' that was 'created' actually came from existing private companies going public, taking advantage of a rising market and putting shares of their company up for sale to the general public.
These companies were already in existence, with dynamic value. It's just that their value was now counted as part of the stock market. So in these cases, wealth wasn't created - it merely changed hands, from a few private owners to millions of stock investors. Realistically, since stock market valuations came down, the amount of money invested in stocks also came down. Much of that money was simply reallocated to other assets... like real estate, bonds, gold, and other commodities.
Stocks are valuable to investors because their prices change, both up and down. If they didn't change, why would investors want them? It would be easier to hold cash - it's more liquid, and there are no transaction fees.
Now, anyone with a computer can see - in an instant - that a stock's price has moved from US$20 to US$25. And anyone with any imagination can see that they could have made a quarter for every dollar they put down. That's how it begins. And that's usually about the time average investors make their first mistake.
Because, as soon as you start looking for a particular stock whose price could rise, you introduce the idea of valuation - that a stock's price is somehow linked to the prospects of the company. But this is true only in the most general understanding of valuation.
If you watch stocks trade on options expiration days, you'll realize that 'valuation' takes a back seat to the infinitely more powerful forces of money flow. The only question is, who's going to be left holding the bag? Watch a stodgy old NYSE stock as options expiration day (the third Friday of every month) approaches. Pay particular attention to the open interest on puts and calls in the vicinity of the current stock price. Like clockwork, the greatest number of people who can be squeezed out of their money at expiration, will be. Whether that means selling down a 'good' stock or pumping up a 'bad' one!
Want to know where the S&P 500 and Nasdaq are headed? You could listen to bulls or bears or stock analysts. You could track unemployment, follow earnings trends, and pay close attention to market gurus and the financial media. But if you really want to know, you should check the "Commitment of Traders" report released every Friday by the Commodity Futures Trading Commission. This report is more valuable than all the economic or technical analysis known to man.
Because this report will tell you what the big money, the money that literally moves the market, is doing. And this is where you'll get your first clue about what's really behind value... and why we prefer to use the realities of Dynamic Market Theory.
You see, 99 times out of 100, you'll find that the big money is doing the exact opposite of what 'the herd' is doing. The investors looking for steady growth, low P/E stocks in which to park their US$100,000 IRA have no idea what they're up against. The big money, the guys with billions upon billions in buying and selling power, WILL have their way. And if that means dropping a low P/E stock even lower, then so be it.
For example: eBay currently trades at 22 times sales, has a P/E above 100 and a 50% premium to its growth rate. It is richly valued, to say the least. Eight million shares are sold short. And the open interest on options is about 2-to- 1 in favor of the puts (investors betting the stock will go down). A lot of people are betting the stock is overvalued... and expecting it to fall.
It's not that they're wrong. It's that they're asking the wrong question.
The single-most important question you need to ask is not whether it's overvalued, but... who's going to make money? When you know the answer to that question, you can make a fortune. That's how the richest people in the world make their money.
Here's what I mean: The top three institutional owners of eBay have about US$3.5 billion in the stock. Add in the next three institutional owners, and you're talking about US$6 billion. So, will the investors who have approximately US$800 million in shorted stock ever turn a profit?
Not likely. The big boys, that is, the top institutional owners, will keep the price up until the shorts call it quits. Or they'll run the price up and 'squeeze' the shorts - handing them bigger and bigger losses - until they give in. And the situation is even worse for the vast number of put options holders.
So, sometimes it pays to poke your head up out of quarterly reports and valuation models and see what's around you. If you find yourself surrounded by a bunch of people who, like you, think they're about to make money... well, you're probably wrong.
The stock market is a game, pure and simple. And there's only one rule: money always wins.
In other words, a lot of that money that 'disappeared' from stocks (equity funds) simply moved into bond and money market funds. The money didn't 'disappear' - it moved. Add to that the moves into gold and real estate, and you begin to see that - allowing for fluctuations in the 'value' that we love to give to the market - money tends to move around more than it 'appears' and 'disappears.'
Point is, all that money didn't just 'vaporize,' as the perennial bears like to claim. A lot of it simply moved. Now money is flowing back into stocks again. But beware - the market is set to fool investors and separate them from their money yet again.
But if you follow Dynamic Market Theory, you're much better positioned to profit... no matter what happens in the stock market. It's a new and different way of investing that takes into account volatile market conditions and the many factors stacked against the individual investor.
Many stocks exhibit certain predictable behaviors before they make a large move... that is, before the money moves into or out of them. Over time, this behavior - shown by any number of indicators - gets recognized, and everyone begins to look for those indicators and act on them. Then the significant factors evolve into something else.
To turn this action into profits, you need a set of individual ways of looking at the dynamic market action of stocks (in other words, price action) to arrive at decisions about how to invest. With these individual systems of looking at dynamic action, you can predict developments in stocks... in any market... by looking at the different indicators.
What's become obvious is that static theories or traditional views of the markets can't and won't work in the long run. Because there is no one set of principles - like value investing - that will always work. Since the market is dynamic and ever-changing, following one investing principle dooms you to failure.
It may work for a short period of time, but once the market factors change, then so must your investing philosophy.
Regards,
Christoph Amberger, for The Daily Reckoning
P.S. If everyone looked for 'value' and bought 'value' based on certain criteria, there would be only buyers for stocks one day, and only sellers another day. Markets just don't work like that. There have to be both buyers and sellers to maintain equilibrium in the markets.
If you're concentrating on only one 'sector' or one style of investing, you're going to fail. Money is constantly flowing from one stock to another, and from one sector to another. This dynamic action is what you must read to be successful.
