INVESTORS got spooked? Well, not everyone. Let's recall the obvious, that every dumped share was bought by a patient buyer. The seller was in a panic, and the buyer was a long-term investor.
This is what Wall Street is talking about when they say, "More money is made in falling markets than in rising ones." Today, we have the Dow Jones average of thirty large companies with dividend payouts that average about 5.5 percent per year. This high percentage return, compared to the historical norm of about 2 percent, is not because dividends have suddenly been jacked way up. It's because stock prices are way below what company profits and dividend flow would normally support.
How can this happen in a rational world? Because there are economic conditions that prompt a total disconnect between stocks and the underlying companies they represent. The value of anything is based upon what a willing buyer will pay a willing seller.
A large company can be making a product, employing people, selling what they make and making a profit. It may also own outright a lot of capital assets and real estate. Taken as a whole, this company may be worth a lot of money, and a willing buyer might pay a substantial sum for the entire operation.
Now, let's look at the shares of that same company that are for sale in the market. The supply and demand for those shares can be buffeted for reasons having little to do with the company's underlying value. Right now, hedge funds and mutual funds are forced to sell their shares in stocks to generate cash for clients who want to cash out. Buyers are reluctant to buy because they are waiting to see how low those shares will drop.
This heavy supply of shares weighed against little demand for them is what caused the share prices to drop so dramatically. Share prices throughout the entire stock market have dropped to about half what they were a year ago. However, many of the underlying companies are just as valuable as they ever were.
The term, "mis-pricing" describes share prices that are disconnected from the true value of the companies they represent. Economists use the term "market inefficiencies" because the market has become inefficient at determining true worth.
This happens when the demand for stock as stock can be different than the demand for the companies themselves. Often when this is the case, entire companies can be taken over by someone with enough money to buy all of the outstanding shares. General Motors, with a stock value of less than two billion, is a candidate for a takeover right now. There are several members of the Forbes 400 with the wherewithal to buy that American icon lock, stock and barrel.
Meanwhile, Michael Moore in the movie ``Farenheit 9/11'' pointed out that the Saudis own roughly 7 percent of the value of all outstanding shares in American companies. Their ambassador told him how much they had invested in American stocks, and dividing by the market's total value, Michael did the math in his head right there onscreen, a simple calculation with a disturbing result. Now could be the Saudis' opportunity to double down. If they did, it would jumpstart the demand for stock and make our 401(k) accounts whole once again.
Opportunists, starting with the Saudis and assorted self-made billionaires, know that the market will rebound sooner or later. Since 1970, there have been five major market "breaks," and the average 12-month rate of return following the lowest point was 19.5 percent.
Most investors who throw in the towel and bail out after losing, say, fifteen to twenty percent, are traumatized and rarely have the stomach to jump back in at the slightest hint of a turnaround. However, acting on that slightest hint is what earns people most of that 19.5 percent, because the bulk of the gain happens close to the bottom. How about that eleven percent gain last Monday? I rest my case.
Selling out locks in losses forever, and human nature stands in the way of ever gaining the money back. Smart money will be bidding up stock prices in a big way sooner or later, and those of us with patience will enjoy another great ride.