“Bulls Return,” read the headline on a daily newsletter that I subscribe to. The article wasn’t referring to next month’s Rodeo Austin. The subject was the stock market, or more specifically, the mostly upward price movement since the big selloff last Christmas Eve.
But if the bulls (buyers) have returned, that implies that they left. If they left, where did they go?
You see, if there were no buyers bidding on stocks, there would be no price to report. Sellers would have no one to sell to. But in macroeconomics class in college, we learned about a concept known as equilibrium (Exhibit 1). That is the point where supply equals demand, such as when a buyer and seller agree upon a mutually beneficial price to exchange ownership.
Exhibit 1. Supply & Demand Diagram
The point where supply and demand curves meet is known as the equilibrium price. If either supply or demand shifts, so does the equilibrium.
(Source: By Dallas.Epperson - Own work, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=18132953)
But don’t confuse equilibrium with stability, the equilibrium price is always subject to change as supply and demand shifts. Such is the case when new information enters the marketplace, resulting in sellers and buyers adjusting their expectations for the future. Take for example what happened last summer when China announced a 25% tariff on US grown soybeans (Exhibit 2).
Exhibit 2. End of day Commodity Futures Price Quotes for Soybeans
Prices fell dramatically when China announced a 25% tariff on US soybeans. (Source: https://www.nasdaq.com)
Before the tariffs were announced, buyers and sellers were trading a bushel of soybeans for around $10.40. But once the news of the tariffs hit the market, sellers quickly adjusted their expectations and lowered the price they were willing to accept down to below $8.60 a bushel. The buyers never went away. Upon hearing the news, buyers anticipated that there would be a LOT more soybeans available without demand from the Chinese and were willing to wait until sellers dropped their price accordingly. It didn’t take long.
The equilibrium price has moved up and down since then as other information has become known, but the buyers and sellers have been there all along, adjusting their expectations as details about negotiations, weather, etc., continually flow into the market.
Like soybeans, stock prices also constantly adjust as new information is reflected in their equilibrium price. The news can concern a single stock, such as an FDA approval for a new drug for a pharmaceutical company. Or it may be a broader economic development that impacts the whole market, such as when the Federal Reserve makes a policy change. While the equilibrium price may change, there are always buyers and sellers.
Some money managers would have you believe that they have some insight that all of the information reflected by the millions of trades each day around the world don’t reflect in their prices. But even if someone does temporarily gain an edge, they are competing against everyone else that are also looking out for their own best interest.
Prices of securities fluctuate based on so many different inputs that even when a particular signal correlates to price movements for a while, profitable trading from that signal becomes increasingly difficult, especially if your trades grow larger due to your short term success. This is largely why I accept that markets, while not perfect, are fair and that current prices will reflect information much faster than I can process it. But investors, like wild animals, don’t always behave like we expect day-to-day.
Instead of worrying about when a bear will wake or a bull will charge, try the following instead:
Accept market returns.
Understand that some investments have higher expected returns and allocate more to those.
Broadly diversify among different assets, sub-assets, countries, and currencies to reduce risk.
Keep cost low.
Have a plan for determining when it is time to make changes that reduces bias and emotion.
If you need help with any of that, get in touch.
Investing involves risk and the possible loss of principal, and there is no guarantee strategies will be successful.
Diversification and rebalancing do not eliminate the risk of market loss.
The soybean example noted is provided for illustrative purposes only, intended only to demonstrate prices incorporating information quickly, and is not to be considered a recommendation to buy or sell any security. It is also not intended to represent a security purchased, sold, or recommended for advisory clients, and it should not be assumed that the investment in the security identified was or will be profitable.