I know there must be reasons and this is a dumb question, but I’m a bit of an abstract thinker and have trouble grasping it from a big picture presepctive. Can someone break this down for me? Can’t we all just kind of agree to just kind of… Reset some numbers or something?
Sincerely,
I’ve never taken an economics class in my life
In: Economics
Unfortunately not, precisely for the reason you correctly pointed out…”value” is effectively man-made, which inherently makes it incredibly subjective.
The abstract of the ‘economy’ is that it’s just the aggregate of one party entering into an agreement with another party…repeated over and over again, at all different sizes and places and times, for lots of different things.
That is to say, one side has to agree to provide the other side with something, at a price that’s agreeable to both…otherwise the transaction won’t occur (assuming there’s no force or manipulation involved).
You can see this everywhere…someone buying a piece of fruit at a farmer’s market or grocery store, someone taking an Uber, someone buying a home, etc.
These people are effectively saying…I value the thing the other person has (fruit, ride, house) as much, or more, than the thing I have (the agreed upon amount of money). Conversely, the other person is saying…I value the thing you have (the agreed upon amount of money), more than I value the thing that I have (fruit, ride, house).
That scenario above plays out in the stock market (which many people think of when they hear the word ‘economy’), but instead of buying a piece of fruit, a ride, or a house, investors are buying a share of a company…which is a sliver of ownership. That sliver of ownership effectively entitles you to a sliver of the company’s profits, both now and in the future, should you still own that share.
In reality, most companies choose to take most, or all, of the profits they make and reinvest them back into the company so that the company can continue to grow. In this scenario, which is most cases, instead of taking your sliver of this year’s profit, you are agreeing to let the company use that money in the hopes that future profits will be even bigger, which should result in your sliver of ownership being worth more than it would’ve been before.
If that sliver of ownership is in a company that’s publicly traded on the stock market, you have the ability to sell your sliver to someone else, or potentially buy a new sliver from another owner. The price at which either of those transactions occur will likely depend on whether or not you feel that sliver of ownership will be worth more, or less, in the future.
The share price of a publicly traded stock reflects the price at which each party was willing to exchange what they had with the other party. Fundamentally that means that one party wanted to own a share, while the other party wanted to get rid of a share.
If the world was to hypothetically hit ‘pause’, then you’d have two unhappy people because neither would get what they wanted.
What we’re seeing a lot of now…which is often described as ‘destroying value’…are investors fleeing the market. Individually these investors all have different concerns depending on who they are and what their age is and what level of risk they are willing to take, but the primary reason for the fleeing is uncertainty. That uncertainty is largely driven by the belief that Covid-19 is going to result in less revenue and less profits for lots and lots of companies around the world.
Without getting into the details, the fundamental value of a company is calculated by adding together all of the company’s future cash flow, adjusted for inflation. If a business gets temporarily shut down, or customers stop coming in for some time, then the value that the current investors already assumed was going to be created this year will diminish, which means the share price will likely go down.
If you’re a young investor, you can generally afford to take a loss now because you have many years to make that back up. And history says timing the market can be dangerous…because the market is very unpredictable in the near term, but exceptionally predictable over time…so you could just stay invested in the market and ride it out.
If you’re an older investor, however, you have far fewer years to make up what you might potentially lose. As such, you’d likely take your money out (sell your stocks), even though it means you would miss out when the market goes back up at some point in the future (which is what the stock market has always done, on average, over time).
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