The Worst Reason to Panic About the Market

Imagine you've just purchased your dream home. It's everything you wanted. Three bedrooms, a backyard, a porch, and a great neighborhood near a nice park. You paid $300,000, which you regard as a fair price and one that fits your budget. You could not be happier.

Then one day you wake up in horror. You check Zillow.com to see your new home's estimated value, and are met with a "page not found" error. Zillow's servers are having a bad morning. A few minutes later the site is back up, but is missing data and offers no estimate of your home's value.

Panic sets in.

"Sweatheart, we have to get out of here," you holler to your wife.

"Take the kids to the neighbors. It's not safe here anymore."

Minutes later Zillow is back and running, verifying your home's estimated value at the same $300,000 you paid for it.

Still, you feel cheated. "We have to sell this place," you inform your family. "It's too dangerous. The value of our home lost 100% of its value before breakfast, and then gained it all back just as fast. I love our home, but this just feels like a casino."

The local news agrees. "It was a wild day on Spruce Street, as the brown house by the cul-de-sac saw its value plunge to $0 before recovering sharply minutes later." The panel of experts all agree that we need a Congressional hearing to assure such madness never happens again. "We can't just be gambling with people's homes."

This story is, of course, ridiculous. No one would ever consider their home worthless because of a five-minute Zillow glitch.

But when we think about the stock market, ridiculous becomes par for the course. Replace "home" with "stock" and "Zillow" with "CNBC," and we've just described the flash crashes of the last three years.

The first flash crash came in May 2010, when computer glitches sent the Dow Jones (DJINDICES: ^DJI  )  down 1,000 points in mere seconds before gaining most of it back just as fast. It was front-page news for days afterwards, and is still discussed three years later. Ever since, the market has been hit with flash crashes in individual stocks in what, as best I can tell, has become a monthly occurrence.

The latest came yesterday. As The Wall Street Journal writes:

Within seconds of the opening bell Thursday, shares of American Electric Power (NYSE: AEP  ) collapsed 54%, trading as low as $22.28 after opening the day at $48.18. Moments later, the stock was back near $48.

NextEra Energy (NYSE: NEE  ) also took a brief stutter. A handful of early trading prices were quoted about 60% below the day's normal trades.

Both companies are fine, thank you very much. No power plants blew up. No lights went out. No dividends were cut. An AEP spokesman confirmed that "None of the trading was based on any news out of the company." NextEra CFO Moray Dewhurst commented:

We are continuing to try to understand exactly what happened in the first few minutes of trading in our stock this morning ... This is naturally a concern for all our shareholders and potential shareholders.

To which I reply, "Are you kidding me?" Guys, go back to work doing what you do -- making power. If you have shareholders whose view of your company is influenced by a few seconds of computer glitches on the NYSE, you are better off without them. And they are better off without you.

A company's value lies in its assets, its people, its brand, and, ultimately, its ability to generate cash flow. Its stock price is completely removed from these details, especially on a minute-to-minute basis. It is no different than comparing a home's true value to its price quoted on Zillow. When you buy a home, you buy it for the actual structure, not the Zillow quote. And when you buy a stock, you are buying an actual business with actual assets run by actual people, not a digital ticker tape.

As fellow Fool Ron Gross says, it's not a stock market, it's a company market.

Try to enjoy your companies as much as you enjoy your home. 

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Read/Post Comments (8) | Recommend This Article (20)

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  • Report this Comment On May 24, 2013, at 6:08 PM, QuietBen wrote:

    Flash crashes do not change either the company's nor shareholders fundamentals. However, their impact on today's automated computer programs can be significant causing distrust in the market place itself. And what is the core of the entire trading system? Psychology, not companies income/balance sheets or shareholders confidence in a particular company. I'm no Luddite, but if the cause of computer "glitches" are not sought out and rectified, then no investor, individual or institutional will believe the next one may be more substantial, last longer, and cause more widespread harm than a few nanoseconds of mere discomfort. Are you able to rule out the possibilities of hacker involvement especially now that we know country sponsored hacks have been targeting infrastructure companies like the ones you mentioned. Maybe those not using computers to automatically trigger sales when a flash crash happens don't lose a few dollars, but that misses the concerns entirely. Remember, even the value of the is based entirely upon our psychological belief that it is in fact worth one dollar, at least for now.

  • Report this Comment On May 24, 2013, at 9:42 PM, petrusimion wrote:

    I don't believe these is entirely true.

    The price of a stock is driven by a lot of factors, but the bottom line is there is a buyer and a seller that are willing to exchange the stock at a certain price. And if they keep agreeing to sell and buy at lower and lower prices the price goes down. At least this is what it is my understanding of the market setting the prices.

    What is interesting is that the trades executing and bringing Nextera price as low as 35.40, were considered valid. They were only marked as Aberrant, which will in turn have them removed from data feds, charts ... And it is true, today charts are not showing that low anymore.

    It happened that I had a number of put options at the Strike price of 50, and an order to sell the options if they got to or under $10.00. Since the price went as low as 34.50, the price of the option should have been around 21.00. However, my brokerage informed me that the orders were not triggered, due to the Aberrant prices, and that the Bid price for the options were never moving up over $10.00.

    What is not clear to me is, if the orders and trades that took place in the stock exchange were executed and considered valid, then the price of the option should have reflected immediately the price of the underlying stock, and should have gone far above $10.00.

    I have to investigate eventually with the exchanges in order to understand the situation, but I would be happy to get anyone's opinion and advise on this situation.

    Another interesting question would be, if the "glitch" happened, due to the rule changing about the start and close of the markets as stated by NYSE, why did it only happen one morning, and why only for these two companies, from the same sector?

    I believe there is more to this than something allowing us to simplify the model up to the houses example.

  • Report this Comment On May 29, 2013, at 6:25 AM, gkirkmf wrote:

    Behavior modification is in order. A small transfer tax of a few cents a share, combined with a rule on how often the price of a share can change (every 10 seconds for instance) would go along way to eliminating "glitches" by eliminating the "glitchers".

  • Report this Comment On May 29, 2013, at 4:26 PM, bernbern0 wrote:

    Morgan: Your articles are so refreshing. Well-needed in these difficult times. Thank you!

  • Report this Comment On May 31, 2013, at 7:39 PM, ravenrgg wrote:

    The problem with this "Don't worry, be happy" attitude is that, if you set a stop loss price, and one of these swings happens, your stock is sold, and goes back up before you can do anything. Right now I don't have any stop loss orders, so I didn't lose anything this time. But that means I need to watch everything during the day, which is the OPPOSITE of what you say we should do.

  • Report this Comment On May 31, 2013, at 8:09 PM, NickD wrote:

    Poor people have stop loses they like to sell on losing investments rich people just buy. lol

  • Report this Comment On June 01, 2013, at 9:23 PM, petrusimion wrote:

    Question is, would you buy Nextera stock now?

  • Report this Comment On June 01, 2013, at 9:23 PM, petrusimion wrote:

    Second question, if you owe, would you sell it or keep it?

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