Investing

Supply and Demand

The law of supply and demand states the price of a good or service is at the intersection of the supply and demand curves of that good or service. In other words, the price is where buyers and sellers come together and agree to transact. The higher the price a buyer is willing to pay usually leads to increased supply while the greater the supply relative to the demand usually leads to lower prices. Lumber is a poster child for the law of supply and demand. As you likely know, the price of lumber has shot up dramatically since the onset of the global pandemic, primarily due to a lack of supply. Demand has increased as well but supply hasn’t been able to keep up with demand as sawmills have been slow to start up again and lumber imports have apparently declined.

In the context of stocks, it’s also a matter of buyers versus sellers. If there are more buyers than sellers then prices are going to go up. If there are more sellers than buyers, then prices are going to go down. Buyers generally outweigh sellers when growth prospects are attractive and the risks to the expected growth are believed to be known and appear manageable. We’ve also observed over the past several years that buyers will outweigh sellers when other viable investment alternatives are scarce. In general, sellers outweigh buyers when risks to expected growth become more apparent and likely. Other negative catalysts such as a sharp rise in interest rates, sharp spikes in volatility, war, etc… also lead to a disproportionate number of sellers relative to buyers.

A different way to think about risk and market declines is to think in terms of what is going to cause there to be more sellers than buyers. Impairments to growth and valuation expectations are probably the two most common selling catalysts. Obviously, exogenous shocks like a global pandemic or war will also likely be major selling catalysts.

Sector rotation is a risk for investors that don’t have broad market exposure. In other words, attempting to pick the stocks, sectors or factors that will perform best can lead to under or no exposure to the actual best performing stocks, sectors or factors. Attempting to determine which stocks, sectors or factors will perform best, let alone time it right, is incredibly difficult and has historically led to long periods of underperformance. Having broad exposure is essential. It’s not sexy and doesn’t make for exciting conversations at social gatherings, but it’s the surest way to growing your investment portfolio over time. Getting rich slowly should be everyone’s goal.