Investors enter the stock market with the same hope as gamblers who enter a casino: the lure of the epic reward. In many ways the stock market is like a casino, investors play against the house. Like a drug, the investor wins a few times and develops a false confidence in his abilities to play the market and becomes a "user". Forgetting that on the other side of his or her transaction is an investment bank or a broker-dealer, the investor usually loses because his beliefs in the stock market are the very cause for his or her demise.
Investors, as I was taught in academia and further continue to read in blogs, message boards and financial articles, believe that demand creates price. We are continually browbeat into this way of investment thinking: a company's stock price with good sales, good profits and a good economy will always rise. As investors, we thought this way until October 1987, when after years of stock market gains, the rug was pulled out from under us. There was no economic calamity prior to this as I remember. In fact, it was in vogue to be associated with Wall Street. Since no looming vrecession or economic dirge really transpired, the stock market proceeded to rise for the next 10 years! Yet, somehow we lost venerable investment banking firms such as L. F. Rothschild and Donaldson, Lufkin and Jenrette.
The eye opener for me was the market boom in internet stocks in the late 1990's and the turn of this century. Here is where I gave up on fundamental analysis and watched investment banks and broker dealers run rampant with price manipulation. Companies that had no earnings whatsoever and the calculation of these earning not yet conceived, were doubling and tripling weeks after their initial public stock offerings (IPO). Global Crossings was one of those internet companies who was touted by Merrill Lynch, and Morgan Stanley, two of the major investment houses on Wall Street. Not long after its IPO, the company disappeared because the company was poorly conceived at best. The NASDAQ Composite average crashed but the DJIA and the S& P 500 remained fairly intact and continued its upward ascent until 2008.
In September 2008 due to insane real estate lending practices by many major and regional banks, the housing market was crippled and the economy finally tumbled. All the major indices declined until March of 2009. What I find ironic and maybe coincidental was in October of 2008, the New York Stock Exchange did away with the specialist system that had existed since the New York Stock Exchange (NYSE) was born. No longer would one firm be able to buy or sell a NYSE listed stock. Prior to this, a computer trading platform called Archipelago came to prominence in the mid 1990's and started funneling trading business away from the NYSE. So what did the NYSE do? They bought the company. The damage had been done, however, and the NYSE specialists had lost their total control of trading in NYSE listed stocks. Now broker-dealer firms that had sufficient capital were trading NYSE stocks for their own accounts. The specialist system on the NYSE was no more and no one really gave this much thought. I just find that the SEC filing in October 2008 changing specialists to designated market makers quite coincidental to the fall in the market. Such information may never be known. Similar to 1987, venerable Wall Street firms such as Lehman Brothers and Bears Stearns, disappeared nearly overnight.
So why this soliloquy? I am trying to illuminate facts that exist to me that the stock market is a business made up of investment banks and broker dealer firms who are not who they are portrayed to be. They are for profit firms and institutions who exist to make money playing a game by their own rules. We have pontificated and glamourized men like Michael Milken, Bernie Madoff, and Jordan Belfort.
In simplest terms, these firms' product are securities. They hold an inventory by buying securities at low levels, raising prices to get other investors to buy until their inventory becomes low or their bag of stocks are just about empty. Then at the highs, these firms will establish short sales because so many investors have purchased stock in street name and quickly drop the price of their stock to cover or buy back their shares and refill their bags of stock. This is why the stocks have rallied from the lows established in March of 2009.
What will continue this rally? Two things. The Dow Jones Industrial Average and stock splits. After following the Dow Jones Industrials Average on a daily basis for the past 31 years, I have experienced much turbulence in this bellwhether indicator and psychological barometer. Yes, the S & P 500 indicator is a better indicator of how the overall stock market is faring however, the Dow Jones Industrial Average (DJIA) is older and more revered as a market indicator. If one really looks at the DJIA, it is an average of 30 blue-chip companies and its average is calculated on a price-weighted basis. What does this mean? Simply, the companies' whose stock price is highest in the Average have more of an effect on the Average's price. The DJIA is not the same average of 10 years ago due to the replacement of some of its lower-priced components with much higher priced ones. The movements in the DJIA will become more exacerbated.
The fuel in the markets of the 1980's and particularly the 1990's are stock splits. In theory as I was taught, stock splits occurred because the price of a stock was too high for the average investor. Usually, a stock is split two shares for every one share outstanding. If you owned one shar of a stock priced at $10, you now had two shares at $5. Same amount right? yes, except the fact that the firms who now trade this stock for their living have twice as many shares and their bag of stocks have suddenly become full. In order to relinquish this inventory, their must raise prices to entice investors to buy stock and empty their bags. If one does research, stock splits are rare. Prices of many Dow components are $70 and above. Coca Cola recently split 2 for 1 and I would expect companies like Boeing and McDonalds to do the same.
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