Show Me The Money

According to a study by the Asian Development Bank in March 2009, 50 trillion US dollars has disappeared from the world's financial assets in 2008. For those who are not used to seeing so many "zeros", if you combined the Federal debt of the United States, Japan and Britain and added the wealth of Bill Gates, Warren Buffet, Li Ka-Shing, Timothy Robinson and the remaining top 50 richest people in the world, we would still be less than half way there.

So with so much money lost, is there anything left to fuel a market recovery?

Although I do not have a crystal ball, or a multi-billion dollar spy satellite network, I know that the answer is yes. Why? Because of two fundamental characteristics of auction markets: The first fundamental characteristic is that all markets are created from a group of transactions involving a buyer and a seller (which create the bid and ask prices). Without these transactions, a market does not exist. Every time a buyer purchases an asset (properties, securities, etc) they must pay cash (either their own or borrowed) to the seller, which (assuming no further transactions) is protected from any depleting asset value. For example if a homebuyer buys a million dollar home, the seller receives one million dollars. If the home loses 100% of its value, the buyer may have lost everything but the seller still has the one million dollars. Some may argue that if the buyer used borrowed funds, he owes one million dollars to the bank so the net value is zero. True; however the seller's one million dollars will not go to the bank and will therefore stay in circulation.

Pessimists will argue that although money still exists, there is considerably less money (50 trillion US dollars less to be more precise), and as such, not nearly enough to raise market values to their previous highs in recent years. And so we now come to the second fundamental characteristic of markets: you do not need volume to move prices. Let's look at a simplified example. Let's say person A has 100 shares of ABC stock, and wants to sell them at $10/share. Person B has 300 shares of ABC stock and wants to sell them at $11/share and person C has 200 shares of ABC stock and wants to sell them at $13/share. Summarized below are the asking prices for ABC stock (known as depth):

Ask Price - Shares

$13 200

$11 300

$10 100

Along comes Mr. Big Shot who sold his home for one million dollars before the crash. He believes that ABC stock is well worth the investment and wants to buy 500 shares. If he buys all 500 shares at the current market prices, he will purchase 100 shares at $10, 300 shares at $11 dollars and 100 shares at $13 dollars. The stock price has just jumped 3 dollars with a single purchase! For those who do not believe such a phenomenon can occur, in July of 2000, the Royal Bank of Canada's investment management arm was charged with several counts of "Portfolio Pumping", or making large purchases of shallow traded securities that their funds held in order to artificially inflate the fund prices and increase their quarterly reported returns.

The money is out there, and we do not need as much money to make significant movements in market prices. I know there are skeptics out there who are saying "Ok but even if you have money, who would invest in the markets?" Let me put forth a third fundamental characteristic of markets. There are two groups of investors, professional and retail. The retail investor is the person who does not have a full understanding of markets, has lost tons of money in 2008, and pulled their assets out to buy a 5% 10 year GIC. The professional trader understands long term markets. This group includes institutional traders, and seasoned investors such as Warren Buffet and myself who also lost tons of money in the markets, but continue to funnel more money into our investments (sometimes we are also called gambling addicts). As the market slump continues, more and more retail investors will leave the markets, reducing the overall number of investors and therefore making it easier to move the markets (see fundamental #2). At some point the professional traders will determine that the majority of the retail investors have fled and that fundamental values have reached bottom and start buying. As the professional investors also tend to be the ones with the money, the combined effect of sideline money hitting the market, along with fewer market participants make for a fantastic recovery.

What do I see in the current markets? First of all I see an increased occurrence of markets rallies on negative news (i.e. markets surged on January 26th 2009, despite numerous layoff announcements), indicating to me that professional traders and speculators are again gaining control of the markets and discouraged retail investors who are still in the markets are accepting that they are stuck for the long haul (not selling). Secondly I see more rallies following sell offs, which indicate to me that the traders are getting back into the markets. In other words, fewer investors and money retuning to the markets. Do I think we've hit bottom? Sure why not. I have a 50% chance of being correct.

This article is not meant to be an in depth economic analysis, but is a logical deduction and it is enough to help me sleep at night and let my money ride.

Timothy Robinson PFP, AICB, CDFA is a Personal Financial Planner and Vice-President at Wealth Management Group. Timothy can be contacted via the website www.WealthManagementGroup.ca for a personal consultation.

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