Think Auction, Not Inflow

The market is at all-time highs. More households own stocks now than at the height of the dot-com bubble, according to some surveys. Fund managers are all in. So who the heck is still going to buy and push stocks higher? This question underpinned a rather cynical (to me) Wall Street Journal column Monday. I have a simple answer: Me.

I mean, not me alone. I am one person and soooo not a high roller, and I am far likelier to be hunched over a sewing machine, jam pot or old book than a trading platform in my free time. But I still do portfolio things now and then, and there are millions upon millions more people out there doing small portfolio things. We are not a massive flood of new buyers, yet we make the market go.

Conventional wisdom says stocks go up when money pours in. Intuitively, it makes sense. Supply and demand drive all prices, including stocks. New money equals higher demand for an asset whose supply is fixed in the short term, so prices rise. But this simple logic quickly gets people to the mistaken belief that stocks need cash on the sidelines—or dry powder, or whichever metaphor you fancy—in order to keep rising. More new money, more new demand.

But this isn’t how it works. Friends, I can make the market move without putting in one new cent.

How so? A scenario: I pop into my account and look at my holdings, and I see this stock I have been souring on. I bought it with a certain thesis in mind. Things went as I expected, and it did well. Now I don’t expect such good things for it, yet I see a lot of people want to buy it. So I decide to help them out and add my shares to the mix, selling it to them at what, in my opinion, is a nice premium. I don’t call them suckers—I just think, one of us will be right, but it was time for me to move on. And if they want to pay me a little more for it, why should I say no?

Even better, now I have cash! And I take that cash and go buy another stock, one I have a fresh, positive opinion of. The company has some new widgets and doohickeys in the pipeline and I think its industry is going to do well. Annoyingly, I have to bid the price a little higher because people aren’t keen to sell, but oh well, I am in this for the long haul, so, click!

In short, in the span of two transactions, doing nothing but selling one stock and buying another, I made stock prices go up. All because I and others were willing to pay a little more to buy.

It works like this because the stock market is a big auction. I accept bids on my things over here, and I make bids over there. The prices go up as long as a critical mass of us is willing to pay a little more. We don’t need new buyers to come in and drive the prices higher, because the market is huge and diverse enough that all the constant selling and buying keeps a big pool of money chasing things. This is one of the joys of a liquid market.

Even if I won the lottery and came in with a few hundred million, it wouldn’t change my overall impact. I would still be buying from some existing owner. My purchase amount and their sale proceeds would cancel each other out on the market’s great big ledger. My money in, their money out. The net flow would be zero. And if their desire to sell outweighed my desire to buy, they might even end up selling to me at a discount, and the price would go down. Even with my “new money” coming in.

All analogies are bad analogies, but this is sort of an investment version of the law of conservation of mass. Because every transaction has a buyer and a seller, and the buying price matches the selling price, no trade of an existing stock can ever represent a net flow into the market. That which goes in always mirrors perfectly that which goes out, offsetting to a nice fat zero.

So how long do bull markets last? As long as the collective universe of investors, overall and on average, remains willing to pay a little more when we buy—whether our cash comes from selling something else, putting a 401(k) contribution to work or what have you. Bear markets start when our collective desire to bid stocks higher turns to a collective willingness to concede a lower price when we sell because we just want to be out of the darned thing. This, replicated over and over across thousands of stocks and millions of portfolios, is what makes stocks slide down that long, grueling slope. It starts gently at first, because there are enough hopeful buyers thinking they are getting a timely discount to put a floor under things. It usually ends with a late bloodbath as declines compound and indiscriminate panic selling reigns.

And that is when a new bull market begins, with those gutsy, risk-loving people willing to think long-term and buy at the most fearful times. And it is their confidence and chutzpah, not their war chests, that starts the cycle anew.

Now then, to the original question, who the heck is still going to buy and push this all-time-high stock market higher? We all are, all of us in the general investing world who want to buy. All those who help us out and buy what we want to sell so that we can get some cash to deploy—and all those who help us out and sell when we are ready to buy. It isn’t earthshattering or especially sexy, but it is decentralized beauty.