During a broad market downturn, the question 'where is the money going?' is based on a common misconception. Market cap is calculated from the last traded price, not total cash invested. When prices fall, that value isn't transferred; it's simply destroyed. As one speaker put it: 'The money was never there.'
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The idea that a billionaire can "spend" their net worth is flawed. Their wealth is primarily in company stock; liquidating it would crash the price and signal a lack of confidence. This misunderstanding of wealth versus income fuels unrealistic proposals for solving global problems.
Ray Dalio argues bubbles burst due to a mechanical liquidity crisis, not just a realization of flawed fundamentals. When asset holders are forced to sell their "wealth" (e.g., stocks) for "money" (cash) simultaneously—for taxes or other needs—the lack of sufficient buyers triggers the collapse.
Bubbles are created when assets like startup equity are valued astronomically, creating immense perceived wealth. However, this "wealth" is not money until it's sold. A crash occurs when events force mass liquidation, revealing a scarcity of actual money to buy the assets.
The massive amount of cash in money market funds isn't from investors selling equities. Instead, it's a direct result of high government interest payments creating a 'cash bubble.' This capital is likely to be forced into risk assets as rates decline, providing significant future fuel for the market.
Economic downturns cause panic, leading people to sell valuable assets like stocks and real estate at a discount. Those with cash and financial knowledge can acquire these assets cheaply, creating significant wealth. It becomes a Black Friday for investors.
The primary driver of market fluctuations is the dramatic shift in attitudes toward risk. In good times, investors become risk-tolerant and chase gains ('Risk is my friend'). In bad times, risk aversion dominates ('Get me out at any price'). This emotional pendulum causes security prices to fluctuate far more than their underlying intrinsic values.
Ray Dalio distinguishes between wealth (like a startup's valuation) and money (spendable cash). Crises occur when too many people try to convert their paper wealth into money at once. The system can't handle the demand, leading to either defaults or massive money printing to cover the claims.
Contrary to popular belief, the 1929 crash wasn't an instantaneous event. It took a full year for public confidence to erode and for the new reality to set in. This illustrates that markets can absorb financial shocks, but they cannot withstand a sustained, spiraling loss of confidence.
The common phrase "healthy correction" wrongly personifies the market, suggesting a downturn is a necessary rest that helps it long-term. This is a flawed analogy. The market isn't a marathon runner that needs to catch its breath; a price drop is just a price drop, not an inherently beneficial or "healthy" event for investors.
Selling in a downturn is driven by two distinct forces: voluntary panic from seeing portfolios in the red and consuming negative media, or forced sales (margin calls, foreclosures) when investors have used too much debt and can't cover their positions.