Tech stocks' phantom gains and losses
The tech market's long ride up made average investors feel a whole lot wealthier. Its recent slump has exaggerated their sense of loss.
Why it matters: The past decade's phenomenal on-paper gains caused a lot of people to forget just how volatile tech stocks are — and how fleeting stock-based wealth can be.
The big picture: Stock prices are supposed to reflect the market's prediction of a company's future profits, and the tech industry is all about making giant promises about the future. Historically, that means that tech stocks go up more than other stocks when the overall market is buoyant — and drop faster when it sinks.
- In other market sectors, companies that reach mature profitability are expected to pay shareholders dividends — actual cash rewards. Tech stocks don't generally do that, making them even more speculative.
Yes, but: Headlines about the stock retreat that focus on trillions of dollars of "value destroyed" or "wealth evaporating" suggest that people have lost actual money. That's not how stocks work.
Be smart: In widening the market's swings, tech's bellwether stocks have left individual investors feeling poorer, which can create a negative feedback loop of reduced spending and slowed growth.
In that sense, lower stock prices can and do affect the real economy. But in nearly every other way, stock prices and wealth-you-can-use are very different things.
How it works: Industry analysts use market value or "cap" (stock price times the number of shares outstanding) as a way to compare individual companies and cheer milestones like Apple's $3-trillion peak. But the concept becomes a treacherous fiction when we try to assume that it is convertible into cash.
That's because stock prices are different from other kinds of prices: They change each time there's a trade.
- If you sell 20 shares of Microsoft, you'll probably get the ticker price. If millions of people (or a few investors with tons of shares) try to sell at once, the price will move lower fast.
All a stock price tells you is "Here's what the most recent people to buy or sell this stock agree that it is worth."
- When trading is light, that's fine. But if large numbers of people try to sell at once, the share price drops fast. Your "wealth" dissolves as you try to grasp it.
- That's why, except in special cases like tender offers, a company's market valuation isn't the same as a company's total price tag. Buying or selling "all the shares" would drive the price way up or down.
Between the lines: Bank money isn't risk-free, either. When everyone pulls their money at once, we call it a bank run (cue up "It's a Wonderful Life").
- But price stability, bank regulation and the Federal Reserve all make cash wealth a lot more reliable than stock wealth.
Flashback: Legendary venture capitalist John Doerr regularly dubbed the PC and internet booms of the '80s and '90s "the greatest legal creation of wealth this planet has ever seen."
- He may well have been right. But "creating wealth" means building companies, creating jobs, inventing products and producing goods. It's a lot more than just pumping up a stock price.
Our thought bubble: The U.S. retirement system's shift from pensions to 401(k)s transformed large swaths of the middle class into stock investors. The ascent of the tech industry made the stock market a lot more volatile. Public understanding of the nature of stock wealth has a lot of catching up to do.
The bottom line: Look at the chart below for an antidote to the one at the top of this story. Even with this year's drop, and even with the potential for steeper losses, the tech market has nearly doubled in five years.