Indian stock markets have corrected close to 20% from their peak of 2015. Chinese markets have performed even more poorly, down nearly 50% from last year. I got asked this really interesting question:
Where does the money go when stock markets crash? After all, those who sell stocks, (because of which the price corrects) must do something with their sale proceeds? Also . . . if markets work on equilibrium, how can everyone lose? Who makes money in a crash?
Why this is particularly interesting for me is because 8 years ago I had the very same question, post the 2008 market crash – Those who are selling stocks must be doing something with their money? This is how one of my former professors explained it to me that time:
No, they are doing nothing with their money. ‘You are just barking the wrong tree’. Think of it this way – Rs 100 was not Rs 100 really. The collective foolishness of people resulted in Rs. 50 being valued at Rs. 100. Central bankers only printed what was right based on production and consumption patterns. People took the money in circulation, started leveraging it and inflated prices of all sorts of things. The value of money just dropped back to reality. That’s all!
I disagreed. The price of gold was appreciating and I believed that everyone had started buying gold – that asset classes have their cycles. Then gold prices started correcting sharply after 2013. Since then, stocks have performed poorly, commodity and oil prices are near multi year lows and real estate promoters are in jail.
If you may, I am on base 2 with my question.
8 years on here is my (revised) question – How much is Rs. 100 worth these days?
Simple answer: No one knows the answer. There is no correct answer. People regularly over and under value money, mostly based on how fearful or greedy they feel. Value of things is bloated out of proportion which gives a sense of enormous riches and availability of more money than there actually exists.
In this endless cycle, those who buy more of asset classes like stocks, the price of which depends upon the assessment of people suffer the most when the value of money corrects itself. The reason is simple – things here are priced based only on what somebody else will be willing to pay for it. What you have in your bank account is real money. Nothing else is real!
Gold, real estate, stocks, commodities are all priced on the basis of human assessment. Sometime back I had written a larger post on this subject here. Here is an excerpt from that post:
How Do You Deal With This Situation?
Is it really possible to time a stock market crash – No.
Markets may be fundamentally weak but could nevertheless keep getting irrationally expensive. Conversely, fundamentally strong markets may not get the price they deserve for many reasons.
Certainly, if you look around carefully you will see some obviously overvalued and undervalued businesses. I am sceptical of the billion dollar valuations for some of the start-up companies these days, but could you be sure – of course not. Who knows how future might pan out?
The right thing to do is to keep enough cash in your bank or in safe fixed income products, at all times. An advice repeated many times but seldom ever followed. Even in the worst of a stock market crash, you should have sufficient ‘cash’ to cover the eventuality of a total lock-down. Remember: So long as it’s in the market, it’s all notional.