The Benefits of Market Corrections

Though nature is normally beautiful, the current Pine Valley fire reminds us how destructive it can also be. The ash and smoke from it have polluted our skies and when the fire is over, the once beautiful forest will be replaced with a scarred and barren landscape. It is sad to watch such destruction. 

On a visit to the beautiful Redwood forests of California, the guide pointed out the scars remaining on the ancient trees from numerous forest fires over the centuries. The fires, he said, had actually been very beneficial as they had cleared away weeds, brush and dead trees, while making room for the majestic redwoods to continue growing.

Capitalism is one of the most successful economic experiments in the history of mankind. As the word implies, it is a system that allows capital (money and resources) to flow freely to where it is most valued. For example, if four gas stations sit on an intersection, money, will flow to the one that provides a quality product at the best price. If the other stations do not improve their products, capitalism, by design, will lead to their failure. Compare today's cell phones to the 2 pound models of 20 years ago, and you will see the free flow of capital in action.

A stock market, in its simplest form, is the place capitalism decides where it wants its money to flow. A well run business will attract investor dollars, but if a better option comes along, the money will follow. When I was young, Kodak dominated the camera industry. Today's youth have likely never heard of an Instamatic camera. Kodak went bankrupt not long ago when capitalism decided that photography had a much brighter future than Kodak's old ideas. Capitalism can be harsh, but time and again it results in better products, at lower prices available to more people.

Is the system always right? Of course not. Like a forest, during good seasons stock markets grow weak companies alongside the good ones. Like a forest, stock markets sometimes need a little fire to clean out the debris. When market fires erupt it gives capital a chance to re-think its past decisions. It gives it a chance to get rid of the Kodaks of the past, and move to the new growth of the future. The term for this process is "Creative Destruction" and it refers to the way capitalism destroys that which is no longer productive and replaces it with something better. This is sometimes a painful process, but it is absolutely necessary to maintain a healthy, vibrant system for the future.

As fires burn on Pine Valley Mountain, while mourning the loss of a forest, also celebrate the normal process by which new forests are created. When Wall Street sometimes resembles a forest fire after several years of uninterrupted growth, appreciate the wonderful process of creative destruction that is clearing out old and inefficient companies and moving money to more promising ones. There are worse things than volatility, which I will discuss next week.