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How does the stock market work?

Let’s consider the trends of the modern stock market. If you have tuned into the financial media, you might have noticed that some experts point to the fact that the stock market is noticeably ahead of itself, when others notice that it is keeping pace with the economy. Who is right in this case? Well, you will need to notice impressive returns to determine the growth of prices for various assets. In some cases, investors and stock market specialists expected such a justification in early 2021. But, the COVID-19 pandemic happened, and the markets got out of control with a new and unprecedented difficulty. So now we are waiting for the pandemic to add new factors to the fundamental complex, making the situation even more volatile as it develops further.

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As of March, we can say that the stock market in its general indicator has “pumped over”:

In January 2021, even before the start of the pandemic, information on Bloomberg showed that the final P/E for the S&P 500 was at the level of 21.30, and the forward P/E-at the level of 18.55. On July 17, the trailing P/E for the S&P 500 was approximately at the level of 23.21, and the forward P / E significantly increased to 25.70. At the end of 2020, the forward P/E for the S&P 500 was 17.8. Remember that the P/E coefficients indicate that the market is ready to pay for shares taking into account past or future earnings. The trailing P/E is a 12-month average, and the forward P / E estimates what the profit indicator will look like in the future.

There is a saying attributed to the economist John Maynard Keynes: “Markets can remain irrational in certain situations for a very long time, even longer than you will be solvent.”This is an important warning for any trader, which should be strictly understood and taken into account. This is important for those who take a big position against the prevailing stock market sentiment, especially “shorts”, which were bearish throughout the last bull market. It can also mean that you have to prepare yourself for rational thinking in order not to play for some time, even several years.

Remember, the proof is in the fundamental pudding, that is, earnings. But you may have to wait a little while until your time comes. At the same time, you may not want to change your chosen long-term strategy. Consider buying a small number of stocks with a diversified approach, or apply cost averaging to purchase discounted stocks when the market is falling. This also applies to stocks, but with a more flexible time horizon. If the stock market takes off, the fundamentals should eventually confirm the price. Sentimentality can show that people are favorable to this action, but the basics should show why people value this action. Here’s the tricky part: this check can take months or even years, depending on how far you are willing to go.

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