I’ve been sharing some of my thoughts on the stock market and investing with family and friends recently, and decided to share here as well. I think there’s a lot of panic and misinformation out there at the moment so I thought it was important to post.
I actually put this on my personal Facebook this morning, and almost immediately received a rebuttal, which I’ve decided to include below the initial post including my response in case you find it useful.
I hope you find this quick piece helpful:
Everyone is currently wondering what’s going on with the market(which by the time this is live today will have had another really rough day).
So, will the market crash?
The market can’t continue at the rate it’s been going, but no one can time when it will ‘correct’. And while there has been some correction the last few weeks, that’s not near what an actual correction would be. This has been an appetizer. We just can’t tell when the real one is coming.
It’s impossible to time so who knows when it’ll happen – but something to keep in mind is the businesses that have lots of debt will be much more likely to be hit hard as interest rates rise. So if you take a company like Apple for example, while by no means immune if the market tanks, it’s a company that has increasing profits/revenue and very little debt and tons of cash. So, they’re not an example of a company that would be in trouble based specifically of the cost of loans increasing(because they don’t need them) and they’ll have the funds to buy other businesses when things are on sale, setting them up to do well on those purchases in the long run. Basically when other companies are bleeding, they have the war chest to capitalize. It’s the opposite problem that many companies find themselves in. So overall they’ll be much less affected(assuming all else equal*- which obviously we can’t predict). Because it’s a specific business that’s A. super profitable, B. won’t be in trouble based on price of loans increasing since they don’t need them, C. growing.
(note: while I’m long on Apple and have been for a long time, I’m not saying to buy it, there’s a million things that could make it drop in price short and long term. Just look, it’s gone down almost 10% in just the last 2 trading days – anything can happen to a price short term. Just using as an example of a company that isn’t as directly affected by the coming rise of interest rates that’s putting fear into so many about what will happen to the market)
Who will be in the most direct trouble are companies that are getting cheap loans right now and whose financials will change a lot when they have to start paying real money for that money. Companies not growing/without comfortable profit that have just gone up because the market overall is going up(basically people buying it because “it’s going up, I should buy”)- they’ll be in trouble. You may not know if you own any like that, but many mutual funds will have a ton of these in them. So, if you’re an investor in the fund that does, you’re an investor in companies like that even if you’re not aware. Many people don’t know much about what they actually own/are invested in.
Forget about buying on whether the price of a company or the market is going up or down. If you had the cash available to do so, would you feel comfortable buying the entire company?(which means there would be no public price to go up or down). If not, you should ask yourself why you’re buying a piece of that company when you wouldn’t want to own the company if you could. It’s likely emotions controlling your decision making instead of logic.
Calculate an expected rate of return based on not just P/E ratio but including growth because a company making $1 today at a 50 P/E for example but that is growing fast and will make $5 in 10 years is significantly better than a company making $2 today at a 25 P/E but not growing.
If you’re comfortable with the return you expect and can’t get a better return elsewhere, make your bet and forget about any short term volatility of the market. It doesn’t really matter what the price is once you’re already in if you plan on holding long term. Determine your desired rate of return, look for businesses that you believe can provide that for you based on the price of the stock and what you think the future earnings will be, and place your bet and forget about the daily price changes.
People like Warren Buffett worry less in market corrections for some of the reasons listed. The prices will still be affected but usually less so, and it’s because his companies are actually good investments and less likely to be pumped up in price by speculation, plus more importantly it’s just a company that makes good money consistently, has a moat, and is growing. Those are the companies that are less affected(still affected but often affects them less), as well as recovering in price more quickly than others that don’t have those things.
Remember price is just a reflection of what people think it’s worth, so during corrections/crashes it’s the bad investments that end up getting clobbered long term because logic starts coming into play, but the good companies a few years later will still be a good investment/back above the price they were because the temporary price change did nothing to affect the actual business economics.
If you’re in investments that aren’t making good money/aren’t growing/you don’t know if it’ll still be around in 10 years – those are the investments you wouldn’t want to be in if a crash happens.
But you shouldn’t attempt to time a market. You also shouldn’t attempt to buy into 100+ companies as if this diversification attempt is going to help you. You cap all upside, but you protect no downside in the event of a market crash. Buy into good businesses instead. You only need a few and you are diversified. Most people bet on 100+ random companies that they know nothing about and call it diversification instead of a few good companies. The math is not going to be kind to them long term. It’s mathematically impossible for them to do well over the long run. They might only do as bad as everyone else, but they won’t do well.
If I asked you to tell me about the companies you’re invested in and why they’re good investments, many people would tell me they don’t understand them. But to try and justify their investments/bets, they’d tell me they’re diversified though. All they’re saying is, “I’m in lots of investments I don’t understand” – as if lots of bad bets somehow equates to one good bet.
So you’re dragging down your returns on purpose as if this will somehow protect your gains? It’s not how it works – you’re just mathematically guaranteeing yourself a mediocre return. It’s the ‘I don’t know anything so let me bet on everything’ strategy. If you go to a roulette table and bet on black and red, you still lose when it lands on 0.
When the market goes up very fast or down very fast, it’s often not because something has changed in the value of these companies to make them all go up or down, it’s because people buy because prices are going up, and sell when prices are going down. They don’t know what to do so they just do what they think everyone else is doing. For an extreme example just look at bitcoin – the humongous up and down swings weren’t related to the changes in the technology, but to the excitement and fear of the buyers and sellers.
When stock prices are going up at very fast %s, usually P/E is going up as well, because the growth of the stock price is growing much faster than the actual company is growing. And it’s not that all the sudden the future of stocks got that much rosier, it’s often that the price has outpaced what’s actually happening with the company, and it’s closer to the point where it will regress back to the mean – in other words, the price will likely correct itself back to where it should be sooner rather than later.
Keep in mind not to get distracted by every quarterly earning report. Let’s pretend we were all judged in 90 day increments. I don’t know about you but my stock would swing so wildly it’d be insane. Like…I’ve produced nothing in the last 90 days. That doesn’t mean the future value of what I’ll produce is 0. But my stock would have dropped 90% if I had to report earnings/results, because people freak out and buy/sell based on their emotions. If the next quarter I produced something, people would again freak out with emotion and buy, even though nothing happened other than they judged the price based on an incorrect sample size in both the buy and the sell decisions. Nothing would have changed- would have been the same as yesterday, it’s just that people would be seeing the end result of certain bets.
People are emotional, and the prices of the market show that, both in response to irrelevant things, and then the response to the response to those irrelevant things. “Okay market is going up we must buy!… wait market going down OMG sell!” If you cut out all irrelevant variables you’d be better off in your ability to make optimal bets, since most people are using emotion instead of logic to make decisions, basically guaranteeing that the best they can possibly do is average, and most people pay a fee for that privilege so most are purposely making -EV bets over the long run even if they don’t understand that’s what they’re doing.
There’s plenty of room for logical people to make good bets and do very, very well long term. You don’t have to be some genius. Even if you only beat the people making bad bets by a few percentage points over the long run, because of compounding that would equate to millions of dollars in extra earnings over your lifetime. All from thinking just a little more logically than the next person.
A good quote to remember in these times:
“In the short run, the market is a voting machine. In the long run, it’s a weighing machine.” – Ben Graham
As mentioned after I posted this on my personal Facebook early this morning, almost immediately someone who I don’t really know but seems likely to be a smart person commented saying that the market would crash globally in the next 6-9 months. I had a friend comment in response letting him know that many people had been attempting to predict a crash since 2014, and that they would have lost out on all of the gains since then. He let them know that it might crash and it might not, but that it’s not wise to try and time it. My response was this:
Agree with (friend #2) 1000% here.
Anyone attempting to predict market timing will be correct some % of the time in small sample sizes, but the amount of time they’re incorrect over the long term will be very high, and if making bets to back up their prediction, those bets will not go well. Even the people that predicted the last market crash, many have survivorship bias in thinking that they knew how to time it, which they did not. Many of those same people like (friend #2) mentioned have been sitting on the sideline incorrectly timing the next crash, and missing out on 3x’ing or more their money.
If every year, I claim the market will crash, at some point I’ll be right, but the cumulative result of all my bets if I was betting on that would not do well unless I was martingaling my position- assuming one had the ability to somehow do that, which they wouldn’t(unless backed by someone else who could).
He responded to our responses letting us know that he works with people like hedge funds and asset managers who invest a lot of money and that they’re all liquidating their assets and seemed to be personally offended that we didn’t agree that he could predict the market, and that anyone who was “stupid enough to think they know better will get wiped out.”
Unfortunately Warren Buffett is unable to predict the market, but luckily I’ve found a guy in my Facebook comments who can.
Look there’s a decent percentage chance he could be right, as I mentioned in my post I think the market prices have got way ahead of the actual values of the companies, and I mean he’s making these predictions at a time the market is already going down quite a bit so it’s not some big stretch that the market could be starting it’s tank now. But he’s not understanding that it’s just one possible outcome, it doesn’t mean it will happen 100% of the time. That’s why so many GREAT traders who predict companies failing often get wiped out completely, because while they might have been 100% correct that a company would tank, if they get the timing wrong they still lose the bet, and winning or losing the bet is not based on the value of the company, it’s based on the stock price, and the stock price is based on human emotion.
Could someone attempting to time the market be right? Sure! There’s millions of people always trying to time the market, so lots of them will be right!
But just remember that “a broken clock is right twice a day.”
Keep in mind there was no logic for why the global market would crash(and macroeconomics have a ridiculous number of variables which is why even the smartest most successful people on the planet say they are unable to time it even if they know it’s coming), other than saying that other people he knew were getting out of the market. Which if anything is the perfect example of what I talk about in my post, that most people make their decisions not on logic, but emotion. “Other people are selling, I’ll sell too”. Again, just to clarify I don’t think selling is wrong. I think not making decisions logically is wrong- that’s what gets people into trouble.
If he’s that confident and attempts to time the market and bet the house on shorting it, if he’s wrong on the exact timing, he’s broke.
If he attempts to time it just in terms of not being in the market, even if he’s accidentally right once, he has to be right twice, both when it’s going to go down and then again when it’s going to go up. Talk about some unlikely probabilities.
It’s a fools game, that a lot of fools play.
“The first principle is that you must not fool yourself – and you are the easiest person to fool.” -Richard Feynman
I think one of the biggest edges you can have in investing is knowing enough to know that you don’t know it all.
In knowing that, you can play a simpler game and not try and overcomplicate things. If you buy good companies at good prices for the long term and let compounding take effect, it’s a profitable, non-stressful way to invest and you don’t have to freak out at every change in the market like most people do.
Again remember this quote when considering your investment decisions in the market:
“In the short run, the market is a voting machine. In the long run, it’s a weighing machine.” – Ben Graham