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How the Market Works

The Stock Market Warnings: Part 1 of 3

Posted by kdadmin on June 29th, 2015.

The Stock Market Warnings: Part 1 of 3

You deserve to understand what is happening in the market.

So I put together a three part series to try to make it a bit more accessible. There are some powerful forces at work in the market, and several of them have recently given up the ghost (think Federal Reserve, Greece, ECB, Swiss / Euro par floor, Oil). I want to do my part to educate you so that you don’t find yourself behind the 2008 ball.

Maybe that’s a bit too far.

Nobody really sees a 2008 style implosion in the near term. But a correction (10% drop) certainly isn’t out of the question. We had a 7% drop in October, 2014, with far less neuroses than we have now.

The graph above spans a 23 year history in the US domestic market. It takes us from the early 90’s, through the Dotcom bubble, the recovery through 2007, the 2008 sub prime meltdown, and the recent stimulus fueled bull market from 2009 to the present. We’re going to break it into three parts.

  • Part 1: Orientation & Hypothesis
  • Part 2: P/E Ratio & Quantitative Easing
  • Part 3: When the Music’s Over

Orientation. Before any of this makes sense, you’ll need to get familiar with the pretty, multi-colored lines in the graph above.

  • The blue line is SPY (an ETF that tracks the S&P 500).
  • The orange line is the PE Ratio of the S&P 500, essentially the amount you pay for each dollar of earnings in a given stock.
  • The red line represents the Federal Reserve’s Quantitative Easing (QE) program, which was designed to stimulate the economy.
  • I drew the green line to show … What do you think?

Take a few minutes. Look at the lines, look at the time periods, try to come up with a few hypotheses about why things happened the way they did, and what it means about how the market works. Try to imagine what you think will happen in the future & why. Here’s a hint. And another one. Jot down your notes. See how you do. I’m hoping that as you see the stories unfold over the next several months, you’ll have a better sense of what is ACTUALLY happening, and why. Maybe you’ll even be able to figure out what to do about it …

p.s. Once we conquer the more staid US stock market, I can take you through what matters to you about what’s happening in Greece. (Just look at the ruckus Greece is causing. Their banks are shuttered for a full week. The German market is heeding the warnings and is down by 4% at 4am eastern, the UK is down by nearly 2%, France is down by 3.3% and other markets around the world are getting pounded. The euro is taking an absolute beating… Just wait until you learn why.)

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