Wednesday, January 14, 2015

Stock Market =/= Economy

I must constantly remind myself this,

"The stock market is not the economy"
"The stock market is not the economy"
"The stock market is not the economy"


If you believe in "intrinsic" value, this is the same logic.

I believe that a stock has a genuinely "fair price", regardless of what the market is pricing it currently. The market sometimes might overprice or underprice a stock, but it shouldn't really deviate too much from it's intrinsic value, unless:
1) market players are working on incorrect calculations on the intrinsic value, or
2) market players are chasing the trend, with no notion of intrinsic value

This is not to diss trend-followers, don't get me wrong. Find a trend, put a good stop loss, let it ride. Profit from the ridiculousness of market players to move a market one way or another. You don't need any notion of intrinsic value to be a good trend follower, just a lot of skill and experience. But alas, that is not my style.

This same logic of of stocks prices deviating around its intrinsic value applies to the economy and stock market as well.

The economy might have a "fair value", but the stock market can price it whatever it wants. The stock market can, and usually, gets ahead of itself, valuing the economy much higher than it is actually worth. Once it starts correcting for that, the stock market also usually discounts too much and prices the economy too cheap. Why? We probably have the trend-followers to thank for that.

My main point is that if you can somehow figure out the intrinsic value of something, short it when it is overvalued, and long it when it is undervalued.

Seems simple enough, but the hard part is figuring out what exactly is the intrinsic value?

Until then, let me repeat to myself,

"The stock market is not the economy"
"The stock market is not the economy"
"The stock market is not the economy"

2 comments:

  1. Good reminder. The charts tell the whole story!!

    ReplyDelete
    Replies
    1. Thanks Dave! Looks like we're in for a much more interesting 2015!

      Delete

Observe the house rules.