Friday, August 17, 2007

Volatile stock markets

Stock markets are volatile. The past few days have shown that. Why though? What do traders drive prices up and down on the basis of news reports. From what I can tell, yesterday’s volatility was caused by more “credit” concerns and the fact that Country Wide Financial had to borrow 11.5 billion dollars so it could continue making home loans. I’m pretty sure I don’t invest in Country Wide Financial – though it could be buried in some mutual fund I own – so I’m perplexed why one company’s troubles must drive down the rest of my portfolio.

If lenders are getting burned by bad loans, then they are going to tighten the criteria for loans and increase the discount rate to cover their losses. As a side affect, this will increase a company's cost of capital. But I would argue, a well run company – the ones we should be investing in - should have little problem getting a loan if they need it. And even if the discount rate is raised a few points, we’re still at historic lows. Do we think GE is going to get turned down by the local bank? No. Do we think GE is going to be affected if their cost of capital goes from 5% or 5.5%? While I’m no expert, I would guess they can maneuver around a half a percent.

My assumption here is that people are emotional and make emotional decisions. Unfortunately emotions often get in the way of sound logic. Circumventing sound logic makes a stock market more volatile. If we all sat back and looked at the big picture, we’d all be better off. Or so I think.

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