What Drove The Market Down (or Up) Yesterday?
Good Morning Relaxing Retirement Subscriber,
Even with all of our focus on the long term, one of the questions I still receive from time to time is, “what drove the market down (or up) so sharply yesterday?”
If you listen to various people discuss this, and tune into multiple financial news broadcasts, you’re going to hear a bunch of different answers on any given day: interest rates, tariff wars, consumer confidence, budget impasse, impending recession, federal debt, President Trump’s tweet this morning, etc.
The real answer is three words: anticipated future earnings!
Everything else you hear is all there to provide filler.
The price anyone is willing to pay for a stock at any point in time is all based on how confident they are, how certain they are about that company’s anticipated earnings in the future.
It’s really that simple. Markets don’t care about what may or may not have happened in the past. They don’t care if a company had its biggest sales year last year, or that their stock price rose 26% year-to-date.
The market only cares about a company’s ability to earn money from this day forward.
A Big Scale
Think of it as a big scale which begins each day in balance. With each piece of news that becomes available, markets weigh the potential impact on…. anticipated future earnings.
Let’s say news comes out that two Americans appeared to experience a severe negative reaction to a popular drug offered by pharmaceutical Company X. The Food and Drug Administration issues a restriction on sales of this drug. Markets instantly want to know one thing and one thing only. What will the impact be on future earnings?
The reduction in price of Company X’s stock will be in direct proportion to the level of uncertainty about…anticipated earnings.
If markets believe this is real and will significantly impact Company X’s anticipated earnings, the price market participants are willing to pay for the stock, or to continue holding the stock, will go down. They will discount the value of the company to take into account the loss of sales revenue of this drug.
38 Days Later
Fast forward another 38 days. The Food and Drug Administration does an impact study and releases a statement saying Company X’s drug was not at fault and no correlation could be found between the two Americans reactions, thus the restriction on sales of the drug is removed.
With sales and revenues returning back to prior levels, the level of uncertainty about anticipated earnings is reduced, and markets feel more confident about Company X. This increased confidence means they’re willing to pay a higher price to own it, thus driving prices back up.
75 Days Later
Fast Forward another 75 days. It’s political season and lawmakers are making campaign stump speeches. One candidate in particular, who is gaining momentum and likely to win the election, has made it his number one goal to take on drug companies for what he refers to as price gouging.
Again, markets want to know what the impact will be on pharmaceutical Company X’s anticipated earnings in the future if this candidate is indeed elected and pursues the course of his campaign rhetoric.
To the degree markets believe this candidate will actually win the election, pursue his goal, and actually get legislation passed placing more regulations on the pharmaceutical industry’s ability to set prices, they will make an assessment of the impact on…. Company X’s anticipated earnings and bid the stock price up or down.
Certainty vs. Uncertainty
This is a microcosm of what goes on in markets all around the world every day. With each piece of micro or macro news that comes out, markets are constantly evaluating their level of certainty about… anticipated future earnings of a given company.
The degree of uncertainty about anticipated future earnings is what drives a company’s stock price down, and the degree of certainty about anticipated future earnings is what drives stock prices up.
Committed To Your Relaxing Retirement,
The Retirement Coach
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(The content of this letter does not constitute a tax opinion. Always consult with a competent tax professional service provider for advice on tax matters specific to your situation.)