Dealing with Stock Market’s Moments of Terror

I received this Whatsapp message from a friend recently, where he wanted my opinion on the post-Budget crash in Indian stocks and how to deal with the same…

My friend’s message reminded me of Howard Marks’ Feb. 2016 memo to clients, where he described the situation in the stock market then –

My buddy Sandy was an airline pilot. When asked to describe his job, he always answers, “hours of boredom punctuated by moments of terror.” The same can be true for investment managers, for whom the last few weeks have been an example of the latter. We’ve seen bad news and prices cascading downward. Investors who thought stocks were priced right 20% ago and oil $70 ago now wonder if they aren’t risky at their new reduced prices.

In the rest of the memo, he went on to explain why Mr. Market – representative of the stock prices – has nothing valuable to offer to investors through his daily mood swings. As he writes –

Especially during downdrafts, many investors impute intelligence to the market and look to it to tell them what’s going on and what to do about it. This is one of the biggest mistakes you can make. As Ben Graham pointed out, the day-to-day market isn’t a fundamental analyst; it’s a barometer of investor sentiment. You just can’t take it too seriously. Market participants have limited insight into what’s really happening in terms of fundamentals, and any intelligence that could be behind their buys and sells is obscured by their emotional swings. It would be wrong to interpret the recent worldwide drop as meaning the market “knows” tough times lay ahead.

…It is the goal of some investors to sell on declines when the subsequent movements will be down, but “buy the dips” when the subsequent movements will be up. If you think you can tell which is which from watching the market movements themselves, then we – again – have a fundamental disagreement. Future price movements can only be predicted on the basis of the relationship between price and fundamentals. And, given the market’s short-term volatility and irrationality, this can only be done in the long-term sense. The market has nothing useful to contribute on this subject.

“Predicting the subsequent movement of stock prices,” I called and told my friend, “or the next mood swing of Mr. Market, whether he will be in the best of his spirits or worst – is a loser’s game. Focusing on where the earnings and cash flows of the underlying businesses you own, or want to own, are going to go long term is what you must focus on.”

I also told him, “Your behaviour and expectations are under your control, and so is the amount of risk you wish to take and the time you have in hand. Stock prices and future returns aren’t under your control and thus you must leave them at what they do best, that is, fluctuate.”

“If owning stocks is a long-term project for you,” warns psychologist Daniel Kahneman, “following their changes constantly is a very, very bad idea. It’s the worst possible thing you can do, because people are so sensitive to short-term losses. If you count your money every day, you’ll be miserable.”

My dear friend, please stop being miserable!

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Also Read – Howard Marks Feb. 2016 Memo