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Comment by TekMol | Hacker News Reader

I am surprised that during a recession, stocks usually tank.

You can either own part of the industry that produces stuff. Or you can own money with which you can place bids on the stuff the industry produces.

During a recession, the industry produces less. Now at first you might say: That is the answer. The industry produces less. So it has less value.

But if the amount of money is the same, the bids per piece of stuff should go up. Because there is the same amount of money bidding on fewer things. So the industry should still make the same amount of money.

Any easy answer to this, why stocks tank during recessions?

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The "money" in the economy is actually mostly credit, and during a recession it contracts (usually from defaults) so the amount of "money" in the system is now less

Since the value of a stock is it's future cash flows discounted to the present and it's had it's current cash flows impacted, usually that makes forecasts revise those future earnings downward lowering the valuation of the company.

Other reasons are assets are sold to make up for lost income needed to pay for expenses, and stocks being liquid often get sold first.

>The "money" in the economy is actually mostly credit

But how can you borrow money to somebody if you don't physically have those money?

The money is created when someone borrows it. But you cannot lend more than a certain multiple of what you have as deposit. This multiple is decided by the central bank.

See fractional reserve banking: https://en.m.wikipedia.org/wiki/Fractional-reserve_banking

    The "money" in the economy is actually mostly credit,
    and during a recession it contracts

What arguments are there to support the theory that a recession (decline in overall productivity) causes the amount of credit in the system to shrink?

From a look at the M2 and M3 money supply, there never seems to have been a contraction:

https://fred.stlouisfed.org/series/M2

https://fred.stlouisfed.org/series/MABMM301USM189S

That seems to be a pretty strong argument against the money contraction theory.

Fractional reserve.

Also, recession causes people to spend less and save more. Further reducing demand.

Another example (I am no expert) is a margin call.

If I am purchasing using $100k of margin and my collateral drops to the point that I no longer have the margin. That 100k is gone. It wasn't a real 100k in the first place, it was leveraged and backed by a volatile asset.

And people sit on their cash because they don't want to make bets on the future.

So they park it in something which is believed to be incredibly safe like money market funds or a savings/checking account because a 0% to 1% rate of return beats the risk of a 20%/50%/100% haircut by investing in anything else which gets hammered by the unwinding of the recession.

Investors also need money. Somebody who loses their job has to access their investments to pay rent. This adds downward pressure on the market since people must sell.

This does not change the fact that the amount of money in the system stays the same.

Before "somebody" lost their job and sold their stock, there were X people holding Y dollars. Afterwards, there are still X people holding Y dollars. Nothing changed. The amount of money available to bid on stuff is still the same. Both, the sum of money and also the average amount per person.

> Before "somebody" lost their job and sold their stock, there were X people holding Y dollars. Afterwards, there are still X people holding Y dollars

Maybe it's better to think of it as X-1 people holding Y+1 dollars :P

But really, I think the above poster answered your question with this bit:

> This adds downward pressure on the market since people must sell

Prices go up when you bid higher than the current price for something, and conversely they go down when you bid lower than the current price.

When someone sells in these situations, it means the current average price has dropped.

Also sometimes, when people are desperate to sell, they can really lowball the value of something causing its overall value to depreciate significantly.

The quantity of money in the system doesn't stay the same. Speculators buy financial assets such as stock and real estate on credit. This increases valuations and causes more speculators to buy financial assets on credit, or at least stop paying back their other debts as fast so they can hold more assets, to capture asset price gains. When the process slows down eventually the expected asset price gains will be lower than the interest owed on the debt, causing a sell off.

That's the basics of how a credit bubble works.

I do not see that reflected in the money supply. No wild swings there:

https://fred.stlouisfed.org/series/M2

https://fred.stlouisfed.org/series/MABMM301USM189S

Depreciation of assets like stocks and real estate will lead to a reduction in value in our portfolios, but not necessarily a reduction in the money supply. Money supply is only one factor here.

> But if the amount of money is the same, the bids per piece of stuff should go up. Because there is the same amount of money bidding on fewer things. So the industry should still make the same amount of money.

That’s not how it works, so your premise is flawed.

Even if it is how it works, that’s not directly related to the stock market, because stock market valuations are speculative based on future earnings, not present earnings. Earning less money is not a prerequisite to a reduced stock valuation; often, growing slower than previously anticipated is enough.

To hoard liquid cash for buying opportunities. If the prices of commodities goes way up, individuals and companies need cash in hand more than the long term assets. Cash is king.

> Because there is the same amount of money bidding on fewer things.

But the reason there are fewer things is because producers are responding to less demand for things. It's not like a recession just knocks out production leaving demand untouched, causing the price to move along the demand/supply curve. You won't have the same amount of money as before being bid on the fewer things.

So consumption goes down and savings go up?

Wouldn't those savings go into the stock market, making stocks more expensive?

No, consumption goes down and savings go down too. One person's spending is another's earnings (which impact savings). The money supply isn't fixed and the amount that money changes hands certainly isn't fixed either.

Because people who are over leveraged need to sell their stock to live, so they sell at “any price”.

For a stock price to fall someone has to sell, and someone has to buy, so someone is taking the long position in said company.

Additionally, the stock price is the belief on future profits so if the horizon looks worse then the past, then people may want to shift investments.

“markets can remain irrational a lot longer than you and I can remain solvent.”

Whenever stocks go down, the real reason is that there is fewer people buying stocks than selling. The justification is obvious: if we know a recession is coming, the gains in stocks will take a hit, and people don't want to buy something that will lose value. So investors will stop buying stocks and some people who are more sensitive to price drops will sell their stocks.

On other words, fear of a recession creates a recession.

This is why the government measure of recession-resistance is called "consumer confidence", not "consider spending" ("aggregate demand").

And if one repeatedly states a narrative?

A credit bubble may pop due to loss of confidence, but the loss of confidence is not purely non-deterministic psychological phenomena, it is due to the interest owed on the debt held by speculators which bought financial assets on credit exceeding the expecting asset price gains from buying or holding more assets. When speculators stop buying more assets on credit, asset gains dry up, and those which bought assets on credit or by slowing payments on other debts in hopes of making gains still have to make payments decreasing quantity of money in market causing sell off.

     fewer people buying stocks than selling

What do you mean? The amount of stocks bought and sold are always exactly the same.

Pay attention to the words. Fewer people buying stocks than selling. The amount of stocks "bought and sold" are the same, the amount of people is not. If what you are saying is true, stocks would always be at the same price since the amount of stock bought and sold are the same!

If one day there are 100 people that want to buy the stock, and the next day there are 10 people interested, the prices will fall.

They mean "fewer people willing to cross the bid-ask spread to buy a stock than the number of people willing to cross the bid-ask spread to sell a stock"; what matters is who is crossing the line? if it's the buyer side of the transaction, price trends up. If the seller is accepting a small % loss on the sale, the price trends down.

The number of shares sold and bought are always exactly the same.

In that case, shouldn't recessions instantly resolve themselves? When the price in stocks goes down significantly there's pretty much a guarantee that it'll come back up eventually, so wouldn't any prudent investor buy the dip?

As the parent comment said, the only explanation that really adds up would be that the amount of "available money" in the economy must be going down as a result of defaults on credit.

There are many factors that enter in this calculation. One of that we don't know which companies will survive a recession. This seems to be an easy answer when looking at Google or Apple, but it is not so clear otherwise. For example, many banks didn't survive 2008. Many tech companies didn't survive 2001. Nobody knows what will be the next group of victims in the coming recession.

Other people have given you pretty good answers already, but...

If you're an individual with some spare cash, buying stocks during a recession is probably a good idea, even if they falling.*

If you're a population, you probably don't have much spare cash.

There's some time lag stuff going on in there too.

*Blah blah 1990s Japan blah blah global diversification.

Because stocks are just the right to a stream of earnings. In a recession companies earn less and the future becomes more uncertain.

Because of the way the math works relatively small changes in future earnings and risk can have a large impact on asset sizes.

    Because stocks are just the right to a stream of earnings

Yes. And money is just the right to bid on the stream of things the industy produces.

If companies produce less, money should also be worth less. As your money is your share of bidding power on those fewer things.

The price of a stock is the ratio of the value of a company and the value of money. And should therefore stay the same if the industy overall produces less stuff.

I guess because the differences between the neoclassical homo economics and the biomachine homo sapiens become relevant when scared? The approximation of people as rational actors falls apart.

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