You cannot ignore the market - ignoring a source of investment opportunities would obviously be a mistake - but you must think for yourself and not allow the market to direct you.
THE STOCK MARKET IS A PRODUCT OF HUMAN ACTION…AND HUMAN ACTION CAN BE HIGHLY IRRATIONAL, FEARFUL AND GREEDY AT TIMES.
As long as humans control the decision-making process in the stock market, the stock market will continue to act like humans. Human emotional action and reaction creates unpredictable cycles of excitement, fear, depression, euphoria, calmness, action and inaction. As humans we are driven by many things, incentives being among the most motivating. And this is likely to repeat itself over time.
As investors, we are constantly battling the supposed need to be more active in our investing because of the perceived notion that activity equals value (or intelligence). Our society has put an incredibly high value on workers being "important" if they're busy. However, in investing, it's quite the contrary. In investing, increased activity can lead to numerous costs both tangible and psychological (transactions, opportunity, recency, anchoring, etc).
Are Money Managers being busy just for the sake of being busy?
If you're guilty of this, as I was for a long period of time, it's ok. This is a problem that's plagued investors for centuries. And it will likely continue through the years with advances in tech and the "shiny new objects" that are created with increased regularity.
As Benjamin Graham said, "the market is only there to serve you, not guide you." However, it seems that we continue to take our cues from Mr. Market on an hourly basis -- with very little concern for the future negative consequences of this short-term thinking. When was the last time you looked at your brokerage statement and said, "why the hell was I down 2%? or 3%? or 10% last month?" The media makes more money from sensational headlines and constantly tell viewers that a stock (or the market) is taking a beating if it's down 2% in one day.
Of course, we can't take ourselves completely off the hook either. We're partly to blame for money managers acting the way they do today because we put so much pressure on them to perform on a daily or monthly basis. We "cut-off" their ability to make decisions that are 3-5 years out and beyond. Because of the pressure we put on them, it's not very often you see a money managers with focused portfolios anymore.
"There are a few investment managers, of course, who are very good-though in the short run, it's difficult to determine whether a great record is due to luck or talent...Most advisors, however, are far better at generating high fees than they are at generating high returns. In truth, their core competence is salesmanship."
Where are the Warren Buffetts of the world putting ~35% of the Berkshire's portfolio in Coca-Cola (NYSE:KO). Or Benjamin Graham investing 25% of his family's money in GEICO. Or Mohnish Pabrai allocating ~40% in Fiat-Chrysler (NYSE:FCAU). Nowadays, these types of managers are "few-and-far" between, however, they do exist. The tough part is trying to find them. It makes it very difficult for the everyday investor to find theses high-quality (value-add) managers because the industry and our instant gratification society has changed the way people manage money today.
...Huge institutional investors, viewed as a group, have long underperformed the unsophisticated index-fund investor who simply sits tight for decades..."A major reason has been fees: Many institutions pay substantial sums to consultants who, in turn, recommend high-fee managers. And that is a fool's game."
Whether it's index funds, mutual funds, robo-advisors, or asset allocations strategies --- it's all about collecting management fees and not losing clients. And in order to collect management fees and keep clients money managers play a twisted game of "closet indexing." They aren't concerned with earning their investors a reasonable rate of return because they're scared.
They're scared of losing their job. They're scared of losing clients. They're scared of getting that dreaded phone call from the boss about relative underperformance. They're scared of running against the herb for fear of being wrong or, even worse, being ostracized from their social networks.
However, independent thought is vital to outperformance. Objective and independent thought will help you profit from a business' underlying fundamentals, rather than market folly and the current price of its stock. Focus on the fundamentals of the business and the quality of that business, not movement in the oft irrational stock price behavior.
As an investor, you are in a great position to take advantage of Mr. Market's irrationality and emotional response when you buy at a discount to the intrinsic value of the underlying business. Contrary to popular belief, an investor needs to envision Mr. Market knowing nothing sometimes (I know that confusing). And by that I mean, the market is right most of the time. It's during the 10-20% of the time when the market "lobs you a softball," that you can take a big swing.
If you visualize Mr. Market as nothing more than a place that quotes stocks based on irrationality and emotion short term, you will consistently look for opportunities that present themselves in your watch list over the long-term.
2008-2009 was such a period. Investors that were able to purchase their top ideas during this period did very well for themselves over the ensuing years.
Likewise, investors who were able to take advantage of the markets irrational fears in late August were rewarded handsomely in various high-quality businesses that were beaten down for no apparent reason. The jury is still out on the August low being a short-term or long-term low, but it doesn't matter much to me. The O&G industry could be such a period right now in certain high-quality businesses.
No one knows when a market (or stock) will bottom. If they say they do, they're likely trying to sell you something. I have no idea and neither does anyone else. Regardless, the market offered up reasonable prices in numerous high-quality names in August and is doing so right now in the O&G sector.
It will be the investors that take advantage of Mr. Market's short-term irrationality and invest in high-quality businesses that have the best chance of enjoying compounded long-term investment success. Speculators and short-term traders will inevitably have an uphill battle as they constantly fight market noise and transaction costs.
So how does an investor combat the perverse human nature to be active for the sake of being active?
Stay independent and objective, focus on high-quality businesses, build (and maintain) your watchlist of those high-quality businesses, continue to compound your knowledge, and be patient and wait for the fat pitch down the middle of the plate. When Mr. Market offers you that pitch, you must swing big. That is the job of a focused long-term investor.
The beauty about this strategy is it does not have to take up your entire day. Just a few hours a week of reading and maintaining your watchlist will do the trick. It may not seem like much right now. However, the returns will add up over time in more ways than you know.
REMEMBER: "the market is only there to serve you, not guide you."
ABOUT THE AUTHOR:
Lukas Neely is a former Hedge Fund Portfolio Manager and author of the Amazon #1 bestselling book (valuation), Value Investing Edge: A Value Investors Journey Through The Unknown. His work has been cited on such sites at TED, Wall Street Journal, Bloomberg, ValueWalk, CBS, GuruFocus, and Seeking Alpha. He is also the co-founder of Vantage Research, the provider high-quality investment idea generation, serving investment funds, portfolio managers, and sophisticated investors. InvestorVantage
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in KO, FCAU over the next 72 hours.