Adventure Economics
Because so many people share in the national pastime known as playing the market (which means, of course, the stock market, and used to refer specifically to the granddaddy of them all, the New York Stock Exchange, but now includes nine markets that are linked electronically), it’s worth your while to know the rudiments. The way to do that is to follow the stock tables and read the daily market summaries. And if you’re really ambitious, you can learn about a few other types of markets— like the bond and futures markets—and think of yourself as a financial polyglot. THE STOCK MARKET
A stock represents a share, or fractional ownership, in a company, and a very fractional one indeed. Large companies have tens of millions of shares outstanding. Companies sell stocks (the first time they do it’s called going public) because they need other people’s money. With a strong base of stockholders’ equity, as the pool of ownership is known, a company can buy machinery, fill orders, pay its executives handsomely (and its workers not so handsomely), and even borrow money.
Stock comes in two forms—common and preferred. The difference lies chiefly in dividend policy (see below) but is also important when a company liquidates. Then the preferred shareholder is, as the designation implies, in a better position than the common shareholder.
A dividend is the reward, or payoff, a company gives the stockholder for investing in it. It’s actually a piece of the profits, but don’t imagine for a minute that all the profits are distributed proportionally. No way: Profits must be plowed back into the company’s operations (and, some might say, into executives’ pockets). But something has to be given to the investor who helped make things happen, so dividends of anywhere from a few cents to a few dollars per share are handed over quarterly. The company sets the dividend rate, and every so often may decide to toss a few more coins the shareholders’ way. But a company, if it is in poor financial shape, may also suspend paying dividends on common stock or cut a dividend. The company, however, must distribute dividends in full to preferred stockholders before it pays common stockholders, so it is the latter who gets their dividends axed first in a pinch.
A capital gain is the profit you make on the sale of your ownership in a company, provided the company has done well, its stock is in demand, and its stock price has risen: You hit big in the market.
A loss is a loss. Today—or the day you bought stock—was not your day.
The stock market is where winners and losers get together. Sometimes it seems like a party, other times like a wake. Big winners and losers determine the mood, because the real market makers are pension funds, banks, corporations, and other money managers, all known as institutional investors. The little guy is just that, and he tends to get swept up in or under the tidal waves institutional investors create. The cardinal rule of any market, the stock market included, is buy low, sell high, but if everyone did that successfully, there’d be no markets to speak of. For any person who buys low, there’s somebody selling low, and for anyone selling high, there’s someone willing to buy high. Why? Because of expectations and greed. A person selling low is trying to cut his losses and figures the worst is yet to come, so it’s time to bail out. And a buyer shelling out big bucks is convinced that stock prices will go still higher, and he wants to cash in, even if belatedly.
The herd instinct accounts for the tidal waves and derives from the fact that people are always looking over their shoulder to see what the next guy is doing. More often than not, for no good reason, they figure he must be right and they must be wrong. Institutional investors can suffer this market paranoia in the worst way, so you see how a herd can form and really trample the market. Since institutions invest in many names, stock prices across the board tend to move in line with each other during big market swings. All sorts of things can affect the herd, from a change in tax legislation to a political assassination. But the herd can also behave in ways that have no obvious explanation, as it did when the bull market began in August 1982. And it can turn tail and run in the other direction, as it did when the market crashed in October 1987. It can also be spot-on correct, as it was throughout the 1990s.
If you watch stocks on a daily or even weekly basis, the numbers will tell the story of how the market is behaving.
The Dow Jones Industrial Average (DJIA), or simply “the Dow,” the most widely used measure of market activity. It’s an index of the price of 30 stocks (but a huge amount of money) which trade on the New York Stock Exchange, or NYSE, where the largest companies are listed. Dow Jones publishes the Wall Street Journal and Barron’s and provides financial information.
NASDAQ stands for National Association of Securities Dealers’ Automated Quotations system. The NASDAQ_ stock market is now the fastest-growing, most technologically advanced market, listing everything from hot new issues to established companies such as Apple Computer. Trading volume is second to the NYSE’s.
AMEX stands for the American Stock Exchange, a distant third in trading volume.
Some other averages are far more comprehensive. Among those widely cited: the Standard & Poor’s 500, which tracks large stocks, and the Russell 2000, which tracks small ones.
Then, too, remember that the stock market isn’t the only market around. There’s the options market, where people buy and sell the rights to buy and sell stocks, believe it or not. This way, for less money than it would take to actually buy stocks outright, people can play the market. Without ever owning a stock, they can win big or lose big on its movement. Playing the options market can be (if that’s possible) even more of a crapshoot than playing the stock market.
Also dicey for some, though useful for others, is the futures market. This market was originally devised to help out farmers and manufacturers who used farm products. Contracts for future delivery (within a few months) of grains, pork bellies, and assorted other items could be bought and sold, providing a hedge against anticipated rising costs or falling revenues. But the market has burgeoned in recent years with the inclusion of a host of new contracts (from foreign exchange to stock indexes) and scores of new players. Today hardly anyone active in the futures market takes actual delivery on a contract. The fastest-growing component of the market is in financial futures—Treasury bills and the like— because fluctuating interest rates are still another cost businessmen want to hedge against and speculators bet against.
Once the staidest of them all, the bond market is not the safe haven many conservative investors think it is. Used to be, a company that wanted to fix its borrowing costs for ten or twenty years would borrow money from investors by issuing bonds. The U.S. Treasury did the same, as did the individual states and thousands of municipalities. The investor would buy the bond, receive a fixed amount of interest each year from the issuer, and get back his principal when the bond matured. Bonds were boring because usually, nothing changed. Prices were steady because interest rates were generally steady. If interest rates moved slightly higher, the resale price of the bond, or its price on the secondary market, moved down a notch. No big deal.