Sometimes, markets come into a state where there seem to be only good things around. Prices just seem to go up. Good news or even any sort of news moves a stock higher. Bad news gets ignored. Every day, you find stock prices going up. What causes the party to end?
Same Jugaad - the forces of creation and destructions: I often refer to the simultaneous existence of the forces of creations and destructions in my posts. The same forces are here also at play. There are cycles everywhere, and stock markets are one perfect example. What goes up, comes down. Forces that push stock prices higher are accompanied by negative/destructive forces all the time. However, at times one force is so prevalent, dominating that the opposite force is invisible, and seems like it is almost non-existent. When only good things seem to be going on, in some corner or somewhere the bad/negative force is just becoming stronger to strike at some point. Every positive force, there is some negative force. Nature (and here markets) exhibit the same. When things are going well, suddenly something unexpected can happen from nowhere, just to act as a brake.
Here are some of the 'destructive' forces that keep getting active as stock prices keep hitting stratospheric heights.
- Diversion of money to other assets: When markets keep going up, it pushes prices for most stocks up and makes them seem expensive. For new prospective players, the other asset classes or markets, like bonds, real estate, gold, commodities seem to offer better values. High stock prices put a brake on the money coming into the stocks and divert them to other markets. Also, existing players also start cutting down their holding by profit-taking and moving money to other markets.
- Fundamental reasons: Sometimes, the market seems to be overpriced, when valued from conventional measures. The cashflow generating ability, or the profitability, is not able to justify the overall value of a company or its stock price in other words. Optimism overextends in a bull market, the same way pessimism is overdone to bring prices too low in a bear market or in panic situations. The fundamentals are likely gravity. They always try to bring the stock prices to some fair levels, based on a company's profit-generating ability. The problem with the power of fundamentals is sometimes, it seems to be powerless (I mean useless or outdated) for an extended period.
- Demand and Supply- basic laws of economics: We all have learned that as prices go up, the supply goes up and demand comes down for most things. The same applies to stocks too. However the funny thing with the market for stocks is...well, this can be a separate post itself. We will talk about it some other day!
- Greed: Greed- having seen the prices only go up, investors forget that the prices can go down too. This shifts the supply curve, as with rising prices, current holders avoid or postpone selling of their holding. They decide to ride a bit longer, as it seems very certain to them that higher prices for the same stocks are just around the corner. This reduces the supply, or selling pressure, causing the prices to move higher initially but in the end, it creates a larger pool of potential sellers.
- Fear- FOMO: The fear of missing out- pushes prices arbitrarily high, and pushes them out of the reasonable valuation. This at some point attracts profit taking and short selling. Plus, the money flowing into stock due to FOMO is mostly hot money, which is likely to find an exit soon.
- Insider Selling: Stock options are generally very generously given to C level executives, and sometimes to many employees across the company. For such people, their most of the net worth is tied to this single employer stock. With rising prices, the cash-out from this group of stockholders provides a supply of the stock. This keeps going up as prices keep going up, which acts as a sort of brake on the bull market and takes money out of the market.
- IPOs and SPACS: Total number of Initial Public Offerings (IPOs) go up as the bull market keeps going up. Also, the size of IPOs also increases. This also takes the money out of the market, and into the balance -sheets and bank accounts of the issuing companies.
- Stock issues by companies: As the market keeps going up, the appetite of investors expands. At some point, the prices of almost every stock seem to be going up. Some companies, who had normally volumes of a few thousand stocks a day, get traded in millions. This provides a great opportunity for most companies to issue fresh new stock, raise good money for expansion, or operating expenses. As an example, some analysts were predicting that Tesla will run out of cash at some point. Thanks to the bull market, and a super-duper bull market in Tesla stocks, the company raised almost 10-20 billion dollars! This money has come out from Tesla stock buyers and has got into the bank accounts of Tesla company. Similarly, NIO has raised around $5-10 billion. Gevo, a company which has a market value of less than $100 million a few months ago, has seen the stock price go up by 1000-1500%! (I am pretty sure, if SEC inquires, there will be some manipulations to push the price higher ;). Anyway, the company just last week announced that it is doing a fresh offering of new stocks worth $350 million!
This is an invisible supply of stocks, which is pulling money out of the market. - Leverage: As the profit just seems so easy to come, many traders start making bigger and bolder trades by going on margin. This borrowing initially, earns money, but when the market starts going down, it acts as a double-edged sword, and results in accelerated selling, as margin-calls force borrowers to liquidate positions.
- Taxes: A bull market also gives larger gains on 1099Bs and tax returns. This causes Uncle Sam to take money from the market in the form of higher tax payments. This also necessitates selling some stock positions so taxes can be paid.
- Purchases of Home, Car, Boat, RV, Diamonds, etc: As stock prices keep going up, some investors like to fulfill their other needs and wants. They sell their stock holding and use the money to buy a home, car, boat, RV, Diamonds, Jewelry, Fine Art, and whatnot. This way the money departs the stock market and gets into other markets. The higher the stock prices go, it offers more and more people opportunities to improve their lifestyle by pending or desired purchases.
- Short Sellers: Believe it or not, higher stock prices attract short Sellers and their selling can also increase supply, and influence the prices to go down. (However, during a bull market, short Sellers as a group have nightmares due to rapid upward movement of stock prices.
Like most other posts on this blog, I think I am not done yet. Probably, I can write some more, but I am out of time right now. Good night.
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