Speaking in very general terms, the stock market is the place where the hopes and fears of investors meet the objective characteristics of publicly traded companies and express themselves in the prices and price movement of little pieces of paper. In today’s world, it’s really the movement of electronic impulses.
More prosaically, supply and demand meet and express themselves in stock prices.
Investors are a diverse lot. We range from day traders to those with five-year horizons. There are institutions and individuals, professionals and amateurs, market timers and the always fully invested, the purely rational (a rare breed) and the highly emotional, the risk averse and even a few risk takers. (A pedantic note: a risk taker transacts in order to acquire risk; he doesn’t care about return. A risk averse person transacts when he sees a favorable risk/reward relationship. What counts as favorable can very widely.)
Despite this diversity, there are recognizable patterns to stock investment. One of them is the way stocks behave at different points in the business cycle.
–stocks in the US tend to start to rise, often very sharply, about six months before the business cycle begins to turn up
–once investors who have been sitting with cash on the sidelines realize that the market has turned, they start to shift that idle cash into stocks. They may do so by buying stock index futures, or they may buy individual stocks–or both. In any event, their main goal is to get a lot of money on the train as fast as possible. Getting the best possible seat can come later.
Not every investor is like this. But there are enough trying to get very large amounts of money reallocated into stocks at the most favorable prices that buying is pretty much across the board.
During this period, stocks are relatively closely correlated.
–as this initial surge into the market subsides, the market gradually shifts toward differentiating among stocks based on their anticipated growth rates and on their pricing.
In other words, as the business cycle matures, stocks become less correlated with each other. The style-agnostic shift from value stocks to secular growth names.
what makes 2013 strange
2013 was the fifth year of the bull market. Yet stocks were more highly correlated with each other than they were in 2009 or 2010. Given the way the stock market usually works, the opposite should have been the case.
Tomorrow: what I think is going on.