Author: Albert Yang
Yang brings more than 16 years of European real estate investment management experience to Harrison Street. He was most recently at Barings Real Estate, where he served as managing director, client portfolio manager responsible for European capital raising, investor relations and client service.
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A common anecdote, somewhat true, is that markets trend because of uninformed traders, who constitute the majority of the traders and have the most money as a group. Therefore, they have the most influence on the market. Uninformed traders are those who don’t know the efficient market hypothesis, or what the intrinsic value of securities are, nor any other methods of security valuations, except maybe a few financial ratios, such as the venerable price/earnings ratio. Nor do they much care. They trade based on emotion. When the market is rising, more and more people start investing.
No doubt, the above scenario is somewhat true, although it is impossible to quantify the effect. But there is another reason why markets trend — because of the interconnections of the economy. As I sit here writing this in March, 2009, the market indexes have dropped by more than half from their peak in October 9, 2007. Since the peak, the market has been trending downward. Why?
First, it became apparent that many subprime mortgages were defaulting. This didn’t hurt most lenders too much at first since they securitized the loans and passed on the credit default risk to the investors of these mortgage-backed securities. The increasing defaults caused credit rating agencies to downgrade mortgage-backed securities, which lessened their value. Then some banks and finance companies started failing, because it became increasingly apparent that banks and finance companies were major buyers of these mortgage-backed securities. With credit rating downgrades, they had to write down the value of these securities, which reduced their own credit rating, and called into question their own viability.