Bananas, Anyone? By Brad Thomason, CPA
There’s this old joke about a couple of economists who get shipwrecked on a deserted island. They find a banana, and set about the business of selling it back and forth to each other. In the end they die of starvation. But not before they both become millionaires from their acumen as traders.
A summer-time rally in the stock market is an atypical event. But here we are. It is human nature to react to a new development with the question, “What caused that?” In the case of the recent surge in prices, there’s no shortage of theories being offered. But the leading one shouldn’t really be grounds for investor happiness.
Is any increase at all, no matter what the cause, a good thing? I guess you could make that case. But the question that really should always be top-of-mind for any investor is, “What do I do next?” So even if all run-ups are good run-ups, having a sense of why they happen can be important to informing the answer about the next step.
Some increases are more trust-worthy than others. Ultimately, it’s earnings that drive stock growth. So if corporate earnings are rising, you can follow the logic of shares going up in a very one-to-one way. Same for productivity growth. Or if you’ve just had a period of significant decline, and it looks like the market is temporarily discounting otherwise robust results, that too could be an easy to understand set-up for soon-to-recover prices. All of these are economically real: something having to do with the core valuation of the shares is changing for the better.
But we don’t have any of those things going on right now. Earnings and productivity are dropping. And it has been forever (2007 ish) since we had a major, sustained downturn. None of what we are seeing right now could realistically be the recovery on an over-shot correction: because those only carry us back to previous values, not new highs.
You remember when pop culture came up with the brand-new acronym, NIMBY? As in, not-in-my-back-yard? Well, we have a new one: TINA. As in, there-is-no-alternative.
Obviously there are alternatives. That’s sort of the point of this whole site.
But the implication of this mentality is significant if you are a stock investor. Essentially what it means is that the value of stocks has little to do with actual value, and a lot to do with market dynamics. Stock investors aren’t buying them because they want them, but because others are buying them and this persistent buying force – brought about primarily by nonexistent yields in bonds – is making the price creep higher. The supply-and-demand equation doesn’t care if the demand is “real” or not. If people keep buying a thing for which the supply is not also rising, the price will go up. Like that banana. We note that it would also be appropriate to insert a musical chairs reference at this juncture…
Why you bought stocks in the first place is, at this point, irrelevant. What matters today is your reason for continuing to hold them, your reason for not moving on to the next thing. If your account is bigger than it was a few months ago, good for you. That’s an important thing. But another important thing is where that balance is likely to be in a few more months. The market can take back what it gives. Pretty easily. So simply knowing that prices have been going up may not be enough. Knowing why matters, too. Not because it changes what has already happened. But because it may give you some insight into what’s likely to happen next.
Being a real millionaire is better than being a banana millionaire. Invest accordingly.