This week I spent a lot of time speaking with clients that had fear that “the market” would continue to hand out irrecoverable losses. This fear was motivating them to take pre-emptive action. In a sort of Part 2 of what was discussed last week, I thought I would explore what may have driven that fear. I think it came from two sources: what they heard and what they saw. Now you may say that, a legitimate cause of fear from previous circumstances drove their panic. I will not disagree, but often as a disciplined investor you have to ignore triggers that remind you of past mistakes and experiences if you want to invest successfully. Finding the opportunity in chaos is a lesson that will not only serve you well investing, but in life altogether. What were some of the headlines stoking the fires of panic? I am sure you heard or read some of them, so let’s cover a couple of them.
On the front page of this week’s edition of Barron’s was “Election follies rattle market“. Here’s an excerpt of the article:
Sentient viewers must become numb to the political messages as they meld into the parade of pitches for local auto dealers and cures for maladies you’d rather not explain to the kids. But it seems that the financial markets may be becoming more sensitive to the presidential cage match.
With the global financial markets in free fall at midweek, politics seemed to be added to the list of usual suspects battering stocks and speculative-grade debt: corporate-earnings disappointments, China, and the ongoing collapse in oil and other commodities.
What strikes me as an interesting phrase is “politics seemed to be added to the list…” For me, there are two things that drive market sentiment: fear and greed. As far as market fundamentals are concerned though, company earnings should be the overriding factor (see my article from last week for more on this). However, if you just read this headline you may get the impression that the uncertainty around which candidate will lead the US in its economic turnaround has a very tangible effect on the performance of the market. I doubt it does and long-term investors should focus on fundamentals.
They should ask a few questions:
- Is the company making money (e.g. revenue)?
- If they are, are they profitable (e.g. earnings)?
- Are they growing both revenue and earnings consistently?
- Do they have a competitive advantage in their sector or industry?
“Yes” answers to the preceding would indicate an investment that won’t likely be influenced by a presidential race.
Ok. One more. On Bloomberg, I found this headline: “Are We Headed for Recession?” First, let me say I cannot really argue with the content of this article because the author does a great job of exploring multiple perspectives of this question. I will only refer to the sensationalism of the headline. Because at this point, most articles with recession in the title will get read if they are written. But let’s just briefly explore the notion of US GDP being negative for 2 consecutive quarters (recession defined). What is GDP? Gross domestic product consists of the value of all goods and services produced in an economy. It is easiest to remember with this equation: C + I + G + (X-M)
- C = consumer spending
- I = capital investment (or business spending)
- G = government spending
- X = exports of goods/services
- M = imports of goods/services
Consumer spending makes up about two-thirds of the total number. I believe consumer spending is the bedrock of GDP not just because it is such a large part, but it also drives business spending. And as the article states, many positives exist in the economy to keep this number strong. Maybe the most important is the relatively low cost of credit. When it is cheaper to borrow, people spend more. Spending leads to revenues and profits for businesses and when businesses have profits they spend. Currently, there are not many signs to show that this is coming to an end anytime soon. Higher interest rates may start to slow spending, but since they are so low now it may be a while before we see spending decrease because of them. I think the other thing to keep in mind is that economic growth will not always correlate to market performance. In a perfect world they probably should as this would make sense that profitable companies warrant higher valuations. However, a down market should not make investors think we are headed towards recession.
I have recently been reading commentary by Howard Marks and he had a wonderful Benjamin Graham quote the other day: “the day-to-day market isn’t a fundamental analyst; it’s a barometer of investor sentiment. I think the quote is pretty self-explanatory and demonstrates that focusing on the short-term volatility of the market is not consistent with investing based on market fundamentals.
No meaningful progress can be made towards investment goals by paying attention to headlines that instill fear, anxiety and panic. Imagine trying to run a race while looking up into the sky waiting for rain or into the stands to see who is watching. What would happen to you? At best, you will likely lose the race, but at worse you may run into someone else’s lane causing injury to yourself and others.