Momentum Stocks: The Great Engine of Wealth CreationKarl Marx says that labor is the only force that creates wealth. No wonder he died poor.
In a capitalist society, desire is the singular force that creates wealth. There is no other force that rivals its potency in wealth creation. Desire is what drives demand and consumption, which in turn drives the economy. The economy creates wealth when there is sustained demand and consumption.
The only definition for wealth is desirability. Wealth is what feels good. Wealth is not definable by physical "things". Undesirable things are junk, not wealth.
Hence, to create wealth, you don't need to manufacture goods and merchandize. All you need is to create desire. If you desire, you shall have.
The stock market has carried this mantra of wealth creation onto unprecedented levels.
How The Stock Market Creates Wealth
The following example illustrates how the stock market creates wealth.
Suppose there are 100 people each holding 100 shares of XYZ Corporation, with each share worthy of 100 dollars. Suppose most of the times, most of these people just want to hold on to the stocks. From time to time, one of them will want to sell. And further suppose that, when this person wants to sell, there is always someone waiting to buy.
If the buyer simply pays the seller 100 dollars for each of his shares, no wealth is created.
But occasionally, the buyer is more eager to buy than the seller is to sell, and he is willing to pay 101 dollars for each of the seller's shares. This, my friend, his eagerness, or desire, to buy is what creates wealth in the stock market.
At the moment when the above trade took place at 101 dollars, 10,000 dollars of wealth is instantly created. At the end of the day, the brokerage houses will be busily updating the accounts of all 100 shareholders to reflect the increase of wealth in their accounts, even though none of them has done a thing during this whole process.
Next time you pay market price to buy a fast moving momentum stock with a $1.00 spread, of some company with 10 million shares outstanding, remember that, even though you have not made a single penny from this trade, you have just created $10,000,000 of wealth for this society.
Now compare this process of wealth creation to, say, spending months toiling the field in order to grow a few bags of potato.
It's true that this vast multimillion dollars of wealth you have just created -- involving very little labor in your part, I might add -- will be instantly squished if the next person places a sell order at the market price. But do not fear. So long as more people place market buy orders than market sell orders, this great engine of wealth creation is intact.
In a previous commentary I have laughed about the accounting methods being used in the markets. Well, I may laugh about it, but this accounting method does make some sense. If someone buys your neighbor's house for a higher price, by association you may feel that your house is more desirable now than it was yesterday (even though it is still the same old house), and you may feel pretty good about it. The accounting method, therefore, is there simply to tally up all the good feelings in the society. If this increase in good feeling leads to higher property taxes that you will need to pay, well, that is just too bad. (The government, you see, wants a portion of your good feeling, eh, wealth.)
Stock Trading As a Zero Sum Game
Stock trading is a zero sum game. If I make X amount of money trading a stock, the other side has to be losing the same amount of money. This is true for stock trading as it is true for potato
trading.
Back to the above example of XYZ Corporation, and ignore for the moment the 99 people who are holding the stock and not selling nor buying. Now when the buyer pays $101/each for 100 shares of stock originally worth $100/each, the seller instantly profited $100. Since nothing has changed in the operation of the underlying XYZ Corporation, we can argue that the buyer just paid $101 for something that is worthy of only $100, and therefore have instantly lost $100. Right?
In the old days of 12 or 16 months ago, only day-traders were there to play the momentum stocks. Day traders, by definition, are a conservative bunch. The only kind of equity they trust is cash in their accounts. They would run some stocks up 200% or more to the top, with some traders making lots of money in the process. Then, those that have made money wanted to take profit, those who bought at the top wanted to take loss (to avoid suffering even bigger loss), and their selling drives the stock back down to the original level it has always been.
A lot of traders made a lot of money in this process. Others lost a lot of money. It is basically a zero sum game -- the amount of money made equals the amount of money lost. It is a zero sum game because everyone involved knew that it was just a game, the underlying company's business has not changed and is not worth the higher price they have paid.
This whole game changes when some of the people who bought at the higher price decide to hold on to the stock, rather than taking profit or loss.
Those people who held on to the stocks, either through sheer laziness or whatever reason, decided to ignore the underlying fundamentals of the companies involved. They decided to hold on to the stocks with the belief that, eventually, the stock will rise again and they will be able to unload the stock to someone else without suffering a loss.
When a lot of people decide to hold on to the stocks, the resulting reduction in selling pressure causes the stock to stop at a price that is higher than the original price before the momentum run started. This, in turn, elevates the wealth of every shareholder, including those who had not participated in the momentum trades.
It seems, then, ignorance is also a great engine of wealth creation in this stock market.
"The New Economy"
When some momentum traders decided to hold on to their losing positions, they helped create wealth by keeping the stock price higher than if they have sold them. (These are the people who sacrifice themselves for the greater good of the society.) The more people who hold on to the stocks, the higher the stock price will be.
The market for momentum stocks has entered a brand new era since late last year. Before then, only some individual Internet traders bought and held the momentum stocks. But the big mutual funds got jealous of the Internet traders and have joined in the game.
Mutual funds are buy-and-holders by default. They don't buy a stock in the morning and take profit in the evening. With their huge buying power, their entrance into the momentum scene has created a unique situation in momentum stocks: now momentum stocks go up and don't seem to come down.
Not wanting to be let behind, the corporations -- yes, the very corporations underneath the high flying stocks in the market -- have also joined in the game. These companies have billions upon billions of cash in their coffers, some of which they have just collected from investors, and they are not content with the money sitting in the bank collecting interest. They have discovered that if they'd invest those money back in the stock market, they can collect much better return for themselves.
So now we have a bit of a circular situation: the companies invest their cash in the high flying stock market, the investment profits boosting their earning, thus further boosting their stock prices ... It was reported that some of these companies even "invested" in their own stocks!
These are great times for day traders. They can now "safely" run the momentum stocks to the top without having to worry that they will crash all the way down.
This brilliant party will too end, but not until the last mutual fund that wants to enter the game have done so. Then, the first mutual funds that entered the game will want to realize profit, and other mutual funds will follow suit. The big and clumsy mutual funds will be left holding the bag in the end.
And the end will be ugly.
01.21.00
