When Jim Cramer first started trading, a stock’s value was based on two simple factors: the underlying company’s fundamentals and the sector’s performance.
But when indexes like the S&P 500 gathered enough power to sway stocks regardless of those factors, everything changed.
Now, market sell-offs can happen because of index futures rather than actual fundamentals, an action that the “Mad Money” host said “is every bit as stupid as it appears” and can drive investors crazy.
That’s why investors need to remain level-headed in the face of widespread downturn. All markets will eventually go down, but investors can make those declines work for them, rather than against them, Cramer said.
The biggest stock-mover out there is “the power of the S&P 500 futures over all individual stocks, including ones that aren’t in the index,” the “Mad Money” host noted.
Futures can crush stocks despite the health of their underlying companies or the skill of their management teams, even though those are still important variables to consider.
“Much of the damage from the crash of 1987, where the Dow fell 508 points in one day … and then plunged again the next day before an anemic recovery, was almost entirely due to the relationship between the futures and the common stocks in the S&P 500,” Cramer said.
Stocks became intensely undervalued, a wave of takeovers ensued, and executives started aggressively buying back their stocks to try and save face in a chaotic marketplace.
That’s when Cramer realized that stocks no longer needed messy fundamentals to nosedive into the danger zone. Stocks were no longer “accurate forecasters of the future,” he said.
These days, S&P 500 futures run the show, and investors should never flinch at stocks going down despite strong fundamentals.
“We’re never going back to those halcyon days where all that really mattered to a stock’s price was the sector’s interaction with the business cycle, along with the worth of the company and the executives who drove it,” Cramer said.