When markets decline or rise in a spectacular fashion, we attempt to try to figure out if there is a way we should have anticipated or seen this and if there is, what action could we have taken. Can the way the markets move at any point in time actually tell us anything?
In a recent memo by the famed Howard Marks of Oak Tree Capital, he argues that the markets really don’t tell us anything. He states that first, it’s important to understand that for this purpose there really isn’t any such thing as “the market”. There’s just a bunch of people who participate in a market. People from all different levels of ability act together to set the market price. The market price therefore merely reflects the average insight of people with varying knowledge, insight, experience and emotion. The goal in investing is to buy things whose price underestimates their true value so we are looking for instances when the market is wrong to accomplish this. If the market was always right, these price inefficiencies would not ever occur. So by definition we must not think the market- that is, the sum of all other investors- knows everything, or knows more than we do, is always right. So logically that leads to why take instruction from a group of people who know less than you do? He goes on to opine: the market does not have above average insight, but it is above average in emotionality. Thus we shouldn’t follow what it dictates. In fact, contrarianism is built on the premise that we generally should do the opposite of what the crowd is doing, especially at the extremes.
As we consider this most recent decline in prices, we witness group movements that have been spectacular almost daily. Oil prices are down 6% one day on reports of oversupply and then up 12% as reports of OPEC possibly reducing output. Other than those who trade minute by minute, who would possibly put themselves in a position of thinking they know which way the next move is going? If analysts think that the price of oil will get back to more historical norms of $60-70 per barrel, does it really matter that the price falls to $28 from $30 or rises from $30 to $34 from day to day now?
Possibilities of further market shocks occurring on negative news out of China, North Korea, Syria or any other country are always there. Large market declines occurred in 2003, 2008 and so far the current decline has the majority of stocks down more than 20% from their 52 week highs. Some news that may suggest we are near a bottom: bearish sentiment is as bleak as we have ever seen, highest odd lot short sales since March 2009 (small investors are bearish), active managers and pension funds are under-exposed to stocks, and the resistance point (the previous low in January) on the S & P 500 index of 1812 has held so far.
Economic news has not been all that bad. Unemployment numbers are steady, corporate earnings while not record-breaking, are good. The price of oil has obviously hurt the oil producers, but low oil prices help consumers, transportation companies, and many others. In this world economy all the world problems are center stage in the news and therefore affect investor emotions, but here at home we are growing as an economy in a slow, steady pace.
In conclusion, the markets’ direction at any time, especially in these highly emotional trading days is unknowable. With that as fact, what we can do is attempt to manage risk by doing due diligence on our money managers and their abilities to ascertain profitable companies to own, and to diversify assets across various investment types that react differently to economic news and the equity market. By allocating assets needed for liquidity in conservative investments, withdrawals can be made without a forced sale of equities at these lower prices. We monitor this allocation per each individual’s needs. We have experienced a number of declines in history and each time proper valuations returned to the companies we invest in and markets grow to new highs. As technology advances allow quicker transactions and now move globally in a lightning fast manner, market volatility has expectantly risen. By developing and adhering to a financial plan temporary volatility becomes inconsequential.