Stock market weighing machine
Best practices to address real world challenges. Widely regarded as the father of value investing, Benjamin Graham was one of the greatest thinkers in the annals of modern finance.
With his contributions to financial literature, Graham and his value-oriented philosophy have had significant influence over the generations of investors that have followed. His most famous student is billionaire Warren Buffett.
Graham understood how markets worked.
He witnessed the euphoria and poor decision-making of the go-go stock market of the s and the crash that followed and recognized the distinct difference between investing and speculating in stocks.
Graham suggested that simply owning stock does not automatically make one an investor. To truly invest, one must be disciplined in decision-making, buying stocks based on fundamental analysis grounded in a firm, value-based approach.
The Market Is a Weighing Machine
Failure to consider the true fundamental value of what one is purchasing is not a characteristic of investing but speculation. Graham also understood that, on any given day, the price for a security is simply whatever the buyer and seller agree to and may not be indicative of its true value. Taken to an extreme, that herd mentality can cause mispricing of not only individual stocks but also broad swathes of the market.
Think back to the technology and housing bubbles and the ridiculous valuations that resulted as greed ran rampant. More recently, the fear that gripped investors in late and early drove equity prices down to exceptionally low levels. At such times, opportunities are created for true investors focused on long-term fundamentals and valuations, although casual market observers may struggle to see either the true risk amid euphoria or the opportunities created in times of panic.
Today, it appears that neither fear nor greed is a broadly prevailing force, but arguably a sense of complacency has taken hold. Market volatility has been unusually low in recent months, even as economic data suggests a marked deceleration in the global economy. That bad news may have ironically even lifted investor sentiment, as expectations were raised that policy makers would step in with additional stimulus in an attempt to boost the economy.
Central bankers around the world have recently announced steps to provide liquidity to the market and attempt to drive interest rates lower through interest rates cuts and additional bond purchase programs commonly referred to as quantitative easing.
The stated intent is to stimulate economic growth, boost employment, and even generate a bit of inflation over time.
The more immediate byproduct of such policy moves has been a boost in the price of stocks and other risk-oriented investments. In large part, the economy is like a huge ship that cannot be easily turned.
Markets move much more quickly in anticipation of turning points, and those expectations have already helped to boost stocks in recent months. The risk today is that the same market forces that have driven equity prices higher over a relatively short period could just as easily become disillusioned if the global economy fails to improve.
If corporate profit growth falls short of expectations, investors could react negatively, and stocks could decline. The recent sense of complacency could be supplanted by skepticism, and the relative calm of recent months could give way to heightened volatility. Sentiment could shift tomorrow, next month, or next year. Nonetheless, it will happen at some point; such is the nature of market cycles.
Why does this matter to the average investor? Countless factors drive stock prices day-to-day, and it may be tempting to make portfolio decisions in response to short-term movements or trends.
Benjamin Graham would suggest that doing so is nothing more than speculation. Instead, investors should focus on the long term, which allows the market to act as a weighing machine that focuses not on short-term volatility but on market fundamentals.
While investors may be able to take advantage of relative value opportunities on a tactical basis, market timing has not proven to be a winning strategy over an extended period. The long-term growth of the economy creates an environment in which resourceful businesses can generate profits that are in turn shared with investors, driving stock returns and wealth creation.
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Attempting to time the markets has proven an ineffective strategy. Investors are best-served to remain focused on the fundamentals that drive long-term market performance rather than speculating on short-term trends that are both unpredictable and fleeting.
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