Stocks drop because there are more sellers than buyers. When this happens, the market makers are forced to buy, and as they do they lower the price. My maternal grandfather, Donald Mortlock, worked as a market maker on Wall Street. If you understand how the price moves when there are more sellers than buyers you also understand that at some price the market finds resistance and the markets stop dropping.
Paul Katzeff of Investor’s Business Daily wrote at the end of last month an article entitled, “Stock Funds Shed $29.29 Billion.” In that article he wrote:
Investors pulled $29.29 billion from stock funds in August, as the market fell.
It was the fourth straight month of outflow and just 5.6% short of July’s $31.06 billion, according to the Investment Company Institute. It was also the seventh highest monthly outflow since the ICI began tracking flow in 1984.
Signs pointed to a slowing of outflow this month.
Here is the chart from Paul Katzeff’s Investor’s Business Daily article. I have highlighted the outflows of 83.31 billion for the past three months in purple ($22.96 + $31.06 + $29.29).
As you can see from this chart, $83.31 billion is a lot of outflow from stock mutual funds. Stocks drop when there are more sellers than buyers. And when there are outflows like this stocks drop precipitously. But the dropping can’t go on forever. Ultimately resistance is met.
The ads for gold always bother me with their line, “Gold has never been worth zero.” Well, the markets have never been worth zero either. If the markets approached zero I would take the chance in my pocket and own every company in the world. Resistance is reached long before then. And the markets have never had a 22 year downward slide from $850 an ounce down to $230 an ounce like gold did between 1980 and 2001. Gold lost 69% of its value over a 21-year period for a consistent annualized loss of 5.5%. The markets have never done something even close to that.
So, no, this summer’s market drop will not continue in a straight line downward. This is not the end of capitalism as we know it. The markets are not hopelessly broken. And the world will not end in 2012. I think I’m the only person to make the news predicting that the world will not end.
This is, however, a good time to rebalance your portfolio. Rebalancing at this time means selling bonds and buying stocks.