The stock market and business cycles since World War II

Stock Market Since 1948

Stock market is the market for shares and the prices of shares depend on the business situation in United States and one of the most important matters is the state of business. Now one of the major wars of the world is going on in Iraq and America is directly involved in it. This will certainly affect the economy in United States, as there has been a lot of expenditure for this war. It is unlikely that America's allies in the previous wars in the area will help this time, apart from United Kingdom. No help can be expected from Saudi Arabia or Kuwait. The results of the wars can be seen from Graph I -given in Appendix. (The Business Cycle)

The effects of some of the previous situations can be seen from the graph-given in Appendix. In World War II the impact led to a booming economy and this led to a collapse at the end of the war. Prior to the war, there was the recession due to the great depression which led to the drop in prices of stocks very rapidly and continuously. This ended only with World War II. There were also subsequent wars in Korea and Vietnam and they also created similar fluctuations, but the impact was not like World War II. The explanation of the impacts of different phases of the economy are theories which say that when a period of recession comes, then at the end there is a very low point which is reached before the recession ends. Then again the economy starts expanding till the peak is reached. These are just observations and there is no particular reason or explanation given for these events. (The Business Cycle) The quantum of growth and decline are also unknown, and it is possible that this depends on the confidence levels of the people in the economy. This is the reason why the growths due to Korean War and Vietnam War were much less than the effects of World War II. In general, the stock market growths and declines also follow the business cycles, unless there is some direct manipulation of the stock market as we have seen in the case of Enron and others.

The buyer is the investor

An investment in the stock market seems to be very attractive and most people would like to make some extra money by investing in the stock market. The funny part is that in stock markets, a shrewd investor can make money even when the market is falling. Then the investment has to be in stocks that will drop in prices and they have to be sold before they are bought. There are also other sectors that do very well when the market tends to go down. These stocks are difficult to trace and there is no guarantee that will always act according to your expectations. They may continue to go up as long as the market is going down, but may start dropping when the market is going up. This is the importance of stock research and that also does not work all the time, and the best method is to use trusted sources. They are generally able to tell you what stocks should be bought or what stocks should be sold. This is the importance of deciding what you want to buy. The next point is getting a favorable time to buy the stock, and there are very important questions like dollar costs averaging, etc. (How to invest in the U.S. Stock Market)

The problem is that one can still end up buying a stock at $20 and being forced to sell it at $10. The share market continually changes direction, and the market never goes up or down, but is always moving around in cycles. But the cycles are not even and that means that if they rise for 5 days, it is not necessary that they will fall for 5 days. The duration of the movement in the direction and the amount of increase and decrease will tell an investor as to whether the stock is going up or down. An example of this is if the market goes up for 5 days and then falls for several weeks, then the stock is probably on the way down, or that the stock is in a negative environment. It is also very difficult to depend on the stock market analyst as one does not know what he is trying to do or who is paying him. Thus the first and most important thing to do is to judge the mood of the market.

Let us take the situation in 2001-02 and at that time, the situation was bad with a tangled market and companies that falsified the books like Enron and WorldCom. At the same time, the amarket also changes direction when least expected. This happens as the market begins to feel at some stage that the situation has reached the bottom of the pit and situation hence forward can only improve. The reports start coming in that CEOs are beginning to feel that the situation of the company will now start improving. The other important indicator is the company buyback news. When the prices of shares are about to reach a bottom, then companies will start buying their own shares. Again, after an increase also the market will drop as it happened in August 2000. The most important thing to remember is that in general the market moves in the opposite direction that it is expected to. (How to Invest in the U.S. Stock Market)

The position of the market

In the language of the market, a stock may be in an overbought position and that means that the market has brought it to a price that cannot be justified by its price to earnings ratio. On this analysis, a lot of analysts would say that the market is overvalued. Another group of analysts give the greatest importance to the market and they say that a stock is overvalued according to an investor only when the investor sells of the stock. The price to earnings ratio is the general indicator of the value of a stock, and the analysts have used it to measure the position of a stock. At the same time, the positions of a stock keep shifting and look at figure 2. The indexes that existed then were still below the figures that existed more than 2 years ago. (Is the market overbought? Do you think stocks are overvalued?)

At the time two years ago, the markets had peaked and then the slide started, from which the economy took a long time to come out of. This was due to the anticipation of the stock market about a bad situation in the economy and that led to a depressed market. According to the analyst, the market situation was improving and one could expect the situation to improve. At the same time, the decision to buy a particular stock does not depend on the general direction of the market. One has to decide what sector to buy, small stocks or large stocks, stocks or funds, etc. this analysis has to be carried out by the investors. (Is the market overbought? Do you think stocks are overvalued?)

While this investment expert was hedging about the expected results, some others were clearer. The analysis of an expert from Morgan Stanley was "Post-bubble shakeouts don't end quickly; it's like peeling away the layers of an onion. NASDAQ was the first layer to go, followed by IT and then Telecom. But there are still more layers to come off this onion. They include the dollar bubble, the property bubble, and the biggest bubble of them all -- the American consumer. The consumer bubble will undoubtedly be the last to go Saving-short and overly-indebted, the aging America population is coming to that point in the life-cycle when it must begin to come to grips with the looming reality of retirement." (Vital Information for Stock Market Investors! What Every Investor Needs To Know) The coming to grips of the American consumer with reality may come due to spike of oil prices, a surge of white collar layoffs or a deflation of the property bubble. (Vital Information for Stock Market Investors! What Every Investor Needs To Know)

All the three are happening now, and does that mean that stock prices are going to come down? Even earlier the bad position was being seen clearly with a record for debts going bad being established in the quarter from April to June 2002. During the entire period from 1953 to 1999, there were no records of household net worth going down for the full year, but it happened in 2000, 2001 and 2002. Thus it is clear that consumers are spending as much as they can. The market had not met trouble as the consumers had spent more and the increase in housing prices. When both of these end as seems to be clear now, then the position of the stock market will be difficult. (Vital Information for Stock Market Investors! What Every Investor Needs To Know)

Regarding increases in the stock market, one has seen in the past that rises take place over a long-term, but the terms are very long. When the Dow crashed in 1929, it took 26 years to regain the ground that was lost. Again it fell to a level below 1000 in 1973 and then it took ten years before that level was reached again. In Japan, the Nikkei fell and has now continued to fall for the last 14 years, and does not seem to be recovering. According to these experts, the best measure for any investor is now to invest in shares that are historically safe and income producing and the income levels are around the historical average of Dow. (Vital Information for Stock Market Investors! What Every Investor Needs To Know)

The study of market history should be based on the real fundamental situations that have happened in the market. At the same time, it is true that the market rarely functions the way the investors' dream they would. (Stock Market Forecast for 2002 and Beyond) It is clear that both of the experts are talking about the same thing, but in diametrically opposite directions. This difference is caused by the bears and bulls. The bears bet on stock prices going down while bulls bet on stock prices going up. In part they are also the reasons for the movement of the stock prices in the way they bet as their money generally follows their inclination.

How to win in the stock market?

The greatest requirement for winning in the stock market is patience. The winners control their impulses and act decisively on trading signals. They do not act on a whim, but they wait for the correct trading time to come, and this is generally provided by experts. Discipline is the correct strategy for successful trading. To a certain extent discipline can be learnt, but there are some individuals who are more disciplined and self-controlled than others. The investor has to find out the individual capacities on this score, and impulsive strategies and tendencies will have to be controlled so that profits can be earned. Research has shown that some individuals have difficulty when their gratification is delayed, though their may be various reasons for it. In other words, those individuals do not like delays in the rewards which they feel they should get immediately. This mentality makes them take small profits immediately instead of waiting for bigger rewards which will come at later dates. (Patience is a virtue)

There are different types of investors -- day traders, swing traders or longer term trend traders. For all of them trying to cash immediately a reward which will be available only later may cause problems. The situation is clearer for a long-term investor as his investment has to be held for a long-term for the profits to be realized. The prices of the stock may vary during the interim period, but investors who have long-term experience know that they will have to wait for the period. On the other hand a new investor tries to collect all the benefit as for every shortage of stock there will be investors who will panic and try to buy their stock back, but that usually results in a loss for them in the long-term. For all types of investors, there are optimum times to sell, and any earlier sell will usually result in a loss.

Selling immediately will not generally lead to very rapid increases in the growth of value of the investment. It has been said many times that looking at the value of one's investments during the course of the trading day is like sitting in front of a slot machine and still not indulge in gambling on that machine. Still patience is a virtue when anyone tries to trade profitable. The general tendency among all humans is to take a position that will permit them to avoid loss at all costs. Generally this tendency protects us from harm, yet sometimes when the future is unknown, it may also cause us to act impulsively. (Patience is a virtue) Still one can only say that this is not a game for the faint hearted, and the best way to look at stock market investments is to take it as money that one could afford to loose.

Conclusion:

As we have seen clearly, stock market fluctuations are clearly not due to business cycles as there is no likelihood of any major change in business position of United States. The cause for fluctuations in the stock market is based on valuation as per the investor. For an individual who wants to earn constant money from the growth of stock values, it is better to invest in mutual funds as they are dealt with by experts.

Appendix

Graph 1 -- Business Activity in United States since 1914

(The Business Cycle)

Figure 2

Index

11/27/01

10/3/03

Change

S& P

-120

DOW

-301

NASDAQ

1936

-55