Thursday, July 6th, 2006...8:16 pm
What Determines the Price of Stocks?
Surprisingly, many people don’t understand the most basic aspect of the stock market, the way stock prices are determined. Here in the United States, with our free economy, the price of each stock is determined by “market forces.” The term “market forces” refers primarily to two very important and very funny men little men: Ben Bernanke and Jim Cramer. Ben Bernanke, of course, is Chairman of the Federal Reserve Bank, and Jim Cramer is America’s most famous investment personality and host of a wild and crazy TV show called “Mad Money” on CNBC.
So how do they do it? Simple. Nearly all serious investors and fund managers watch Jim Cramer’s show every night. He talks about dozens of stocks, and takes calls from many callers with questions about stocks in his “Lightning Round.” When he likes a stock, he says “Buy! Buy! Buy!” very fast, waves his arms excitedly, and presses buttons to make bullish sounds. This elicits a Pavlov-style reaction from greedy investors who rush out and begin to buy tons of that stock from people who now know their stock is more valuable. The result is that the price goes up, up, up. Sometimes he doesn’t like a stock, and says “Sell! Sell! Sell!” This makes everyone want to sell, and forces the price to go lower. But mostly he talks about stocks he likes, so on the average, the stock market goes up. Plus his show is very entertaining, which makes people happy and willing to buy more stocks and drive up the price.
Of course, it’s not as simple as that. There are some more complicated effects going on. For example, Mr. Cramer also shouts and screams and displays animated graphics and throw chairs across the TV studio and tear off the heads of bulls and plays many other funny sound effects and waves his latest book around while people shout “Boo-Yah!” over the phone. (That’s another fun part of Mr. Cramer’s show – the phrase “Boo-Yah,” like “Ditto” on the Rush Limbaugh show, means “I don’t know what you’re talking about, but I am ready to believe everything you say.”) All this may sound complicated, but it works and usually helps our economy to grow. It’s a beautiful mechanism, this free market of ours.
But the stock market can’t go up forever. That’s where Mr. Bernanke comes in. Just like his predecessor, Alan Greenspan, Mr. Bernanke plays a much more subdued but potent role. He is not on television every night. He does not scream and shout and throw chairs across the TV studio and tear off the heads of bulls or play funny sound effects and wave his latest book around while people shout “Boo-Yah!” In fact, he’s very boring, but also very scary. He only comes out from his crypt for a few minutes every few weeks or months, but when he does, everyone gets very worried that he might not be happy. It is not good when he is not happy, because he is the most powerful man in the world and can do whatever he wants to the economy by changing interest rates, which determine whether companies and the whole economy will have money to grow or whether they will shrivel and die. So when Mr. Bernanke is worried that the market has gone up too much or when he’s just feeling grouchy, he comes out and says “Boo!” (well, actually he uses many more words than just that one, but they all boil down to “Boo!”) and then all investors become really scared and start selling everything so that prices go down again.
When prices go down, that is called a “correction,” and market analysts tell us that this is good and healthy, even though everybody is poorer now. But then Mr. Cramer comes back on TV and says that since everything is cheap now, it’s a great time to “Buy! Buy! Buy!” and soon everyone starts buying and the market goes back up. This is how we get cycles in the market.
Cramer and Bernanke, yin and yang, light and darkness – they are all part of one great cosmic whole, each element playing its unique role.