Volatility

Forty percent of a stock's price movement is due to the market, thirty percent to the sector, and only thirty percent to the stock itself. Famed Hedge fund manager Stanley Drukenmiller said,

“I focus my analysis on seeking to identify the factors that are strongly correlated to a stock’s price movement as opposed to looking at all the fundamentals. Frankly, even today, many analysts still don’t know what makes their particular stocks go up and down.”

To address the matter of price fluctuation, we must first consider what gives a financial

asset, tangible or not, economic value. An asset represents a claim on future goods and services. Owning a share of stock or debt issued by a firm is a claim on the firm’s future earnings, which in turn is based on its ability to create real products or services that have monetary value. The same is true for real estate, which yields real services to homeowners or renters that can be monetized. Owning a government bond is in principle a claim on future government revenues, which could come from taxes or other sources.

Gold is different. It has an intrinsic value based on its industrial use, and it is also used in jewelry. But its market value seems far greater than its intrinsic value based on these uses. It appears that gold derives its value mainly from scarcity rather than its usefulness or any claim it offers of a future flow of goods and services. Scarcity by itself is clearly not enough; there must be enough demand for an asset as well. Such demand could hang on a thread as thin as a collective belief in the market value of the asset – if you think there are other people who value gold as much as you do and enough people feel the same way, gold has value.

So is Bitcoin just a digital version of gold, with its value determined mainly by its scarcity? The limit of twenty-one million bitcoins is hardcoded into the algorithm, making it scarce by design. But there still needs to be demand for it, as even Bitcoin cannot escape the basic laws of market economics, especially the determination of prices based on supply and demand. Such demand could of course be purely speculative in nature, as seems to be the case for now.

It does take remarkable amounts of computing power and electricity to mine Bitcoin, and unfortunately, computers and electricity must be paid for in real money- which is still represented by fiat currencies. It has been argued that Bitcoin’s baseline price is determined by this mining cost. One research company estimated the electricity cost of mining one bitcoin in the United States to be about $6,800 in 2022. Another company estimated the overall break-even cost of mining a bitcoin in 2022 at $10,000, suggesting that this constituted a floor for its price. But this is hardly reasonable logic. Bitcoin’s prodigious consumption of resources cannot create demand for it and, therefore, cannot by itself serve as a justification for its price. Bitcoin’s valuation is built entirely on a fragile foundation of faith. As one influential Bitcoin blogger puts it: “Bitcoin is the first scarce digital object the world has ever seen… Surely this digital scarcity has value.” Time will tell.

Stock prices fluctuate in short, because opinions about information fluctuate. Information comes in many forms: earnings reports, press releases, news stories, court filings, Tweets, general hype, you name it. Investors, whether consciously or not, incorporate each new piece of information they come across into their impression of an enterprise. Of course, every investor reacts to new information differently, and those reactions can range widely from apathy to panic to euphoria. Depending on their reaction, investors may choose to buy more shares, hold the shares they have, or even sell. In turn, these reactions are incorporated into the valuation causing fluctuations in price. Interestingly, the change in share price itself is information that is incorporated by subsequent bidders, and the cycle of information-reaction-price move-information repeats once again.

No matter how calm you are, no matter how long term an investor you are, no matter what your horizons, when the vicissitudes of market forces push and pull, you feel it. Maybe you feel nervous, maybe you feel fortunate. As economist John Maynard Keynes allegedly once said in the 1930's:

"The markets can remain irrational longer than you can remain solvent."

On Wall Street reverence for the irreverence of market chaos is essential to ones success.