When I was asked to comment on the most recent stock market decline, my initial reaction was: markets go up and they go down. America is a great country, but the U.S. Constitution doesn’t guarantee always-rising markets.
I sat down intending to write a reassuring message. I wanted to express my empathy. I found, though, that my reservoir of empathy was empty. After that recent decline, the market was still up 20-something percent from the beginning of 2017.
Then I stumbled on billionaire Ray Dalio and Morgan Stanley’s chief equity strategist Michael Wilson predicting what the market will do next. Then, I started writing what appears below.
Back in February, on the MarketWatch homepage, I saw two contradictory headlines right next to each other:
Investors and CFOs alike, I want to let you in on a small Wall Street secret: Neither Dalio nor Wilson knows what the stock market will do next. Don’t be fooled by their fancy pedigrees, the gazillions of dollars they manage, the eloquence of their logic, and the myriad data points they marshal.
Nobody, but nobody, knows what the stock market will do tomorrow, next week, or next year. Stock market behavior in the short term is completely random. Completely! You’ll have a better luck predicting the next card at a blackjack table than guessing what the stock market will do next.
The media, of course, needs to fill pages and rack up views, and so there’s a plethora of explanations for why the stock market does this or that. The explanations always sound rational, but for the most part they are worthless because they have zero forecasting power.
A strong jobs report sent stocks up. Explanation: The economy is doing great. A strong jobs report sent stocks down. Explanation: Investors are worried about higher interest rates. I can give dual spin to any news, short only of nuclear war, maybe.
My biggest problem with “The stock market will do this” headlines is that they turn investors into degenerate gamblers. I see people trying to treat the stock market like a casino. They get lucky at times and catch the wave of randomness (especially if the market marches higher every single day). Success goes to their heads, and the feel like they’ve got this whole market thing figured out.
I don’t even want to insult gambling by calling this gambling. At least gamblers generally don’t gamble with their life savings and 401k’s (unless they’re degenerate gamblers). Stocks are just bits of data that are priced on the exchanges a mind-numbing number of times a day.
What will the stock market do next?
It’s the wrong question. It’s the question that should never be asked, and if asked should never be answered. Asking it shows that you believe there is some kind of order to this random madness. There is not. And if you answer other than “I don’t know,” you’re a liar.
How do you deal with market declines? Stop looking at the market as if it were a casino and start treating stocks as businesses that you are trying to buy at a discount to fair value.
Stock price is an opinion of what the market is willing to pay for this business right now. Yes, it’s an opinion, not a final judgment. The stock market is going to be a miserable place for anyone who take market opinions on any given day seriously and treats them as final judgments.
By treating stocks as businesses and analyzing and valuing them as such, market drops stop being a source of pain and turn into a source of pleasure. Most money is made during bear markets, when stocks are cheap; it just doesn’t feel that way at the time.
Even for someone who is fully invested, why does it matter that the market decided to price their stocks lower today (unless they believe the market is right). The correct question is, will it matter three or five years from now?
Undervalued companies may get more undervalued before they become fully valued. An investor who has the valuation right will eventually be proven right.
Let me tell you what we did when the market took a dive. We looked at stocks we owned and asked ourselves: Had their values changed? They had not. Then we asked if we wanted to increase our positions in any of them. Then we looked through our long watch list to see if any stocks had hit our buy-price targets.
That was it. That is the only rational way to invest.
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