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July, 2018:

What Drives the Prices of an Asset?

One is missing a very big part of the market if one restrict themselves to investing in stocks.  While it is obviously true that some companies bring in more profits than others, and subsequently their company’s stocks perform better, just as importantly (if not more) is what is happening to the entire asset class as a whole.   If the entire residential real estate market is crashing down where you live, installing new hardwood floors and granite countertops isn’t going to help you recover what you paid.  In the same way, your stock doing 20% better than its peers isn’t going to help you much if the whole market has dropped 40%.

How an asset class performs is generally based on a few major factors.  Is the supply of money in the world increasing or decreasing?  Are people throwing said money around more often or less often?   And, obviously, what are they throwing that money at?

Much of the time, you’re going to get conflicting signals.  Maybe the money supply is shrinking, but stocks happen to be the most popular asset class.  In fact, rarely will you find all the signals pointing in the same direction.  One of those rare times was the run-up to the beginning of our current depression towards the asset class whose bubble ended up bursting… real estate.  When more and more money was being pumped into the system, via the federal reserve, people had more and more money to spend.  Banks were issuing more and more credit (more on credit creation later), and interest rates were dropping, meaning that people could afford to borrow more and more money.  Now that lead to an increase of price in most asset classes, but none moreso than the favorite asset class of the middle class, residential real estate, for the simple reason that your “investment” is something that you live in.

And as long as all of those factors stay moving in a forward direction, you can rest assured that prices will keep going up.

But of course interest rates can only go so low.  One can only take so much debt before they reach a level that they cannot pay back.   And when some of those factors that push the amount of money in the asset class’ system start to turn to the other direction…  well, you know what happens next.