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An abundance of people are saying that it is a particularly uncertain time for the market at present. Investors have to contend with a multitude of factors, on a range of fronts, and there is heated debate as to their likely outcome and the impact on securities. The smart investor, we are told, is sensibly sitting on the sidelines and waiting for clarity before returning to the market.
What a crock! Like so much market commentary it is difficult to deny the general idea, but the practicality is highly questionable. The point I would make is: when is there ever certainty on the market? Even in very bullish periods, where the outlook is unanimously positive, uncertainty nevertheless abounds. It just centers on different things, such as how positive the outlook is, whether or not stocks are overvalued, and how prolonged the good times will last.
Hypothetically, let’s say that European nations embark on respectable austerity measures that act to abate current concerns over sovereign debt. Let us also assume that the US economy continues to recover, albeit slowly, and that China avoids any serious issues.
Do you think that all uncertainty in the market will completely evaporate? Do you suppose that the early, tentative signals of strength will be instantly embraced and endorsed equally by all? Are you foolish enough to think that the current uncertainties won’t be soon replaced by a completely new, and at this stage unforeseen, set of concerns? Give me a break.
Besides, who cares if there is uncertainty? It is the very nature of the beast when it comes to markets and something pragmatists should simply accept and move on. If you cannot get past it, then your investment dollar is better served by term deposits and bonds which offer the closest thing to certainty in the financial world. Just understand that the compromise here is relatively benign returns.
Of all people, short term traders have the least to complain about. Given their proclivity for risk mitigation strategies (e.g. stop loss orders), and the ability to take short positions, I would have thought that the more uncertainty, and hence more volatility, the better. Up, down or sideways shouldn’t matter for the sophisticated trader.
Investors too shouldn’t be concerned. It is said that a fool is someone who knows the price of everything and the value of nothing. This is especially true in regards to the market. Whilst uncertainty can cause prices to fluctuate wildly, the real intrinsic value of a business rarely changes significantly in the short term. Instead of focusing on price alone, sensible investors should instead focus their attention on the performance of the business and the potential they offer for providing attractive dividends.
The recent example with the Commonwealth Bank (CBA) is telling. The uncertainty associated with the Credit Crunch saw its share price drop a massive 60% between November 2007 and January 2008. However, the bank’s earnings and dividends declined by less than 15% and have since recovered to record levels.
From a fundamental standpoint, there was simply no justification for such a massive plunge in value. It is easy of course to look at things in hindsight, but even during the worst of the crisis the CBA repeatedly said that it was well capitalised and that its long term outlook remained attractive.
Even though we can see that CBA avoided the worst of the credit crunch, there are now a whole host of other uncertainties that plague the share price. Some are worried about a downturn in the property market, others warn of increased funding costs, and the list goes on. These issues will eventually resolve themselves, but there will soon be other issues that will take their place. My point being, to thoroughly ensure this dead horse is properly flogged, is that there will ALWAYS be uncertainty.
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What we need to understand is that short term price fluctuations reveal little about the true long term value of a business. The day to day change in price is more a function of market sentiment; a fickle and temperamental beast driven by our least noble emotions. If you rush to hit the sell button after every dip in price, all you do is lock in losses and forgo participating in the real growth of the business.
Understand that I’m not saying you should never sell when share prices fall, just that your decision to sell should never be based on price alone. The same goes for buying; to quote Warren Buffet, “price is what you pay, value is what you get.”
Markets are uncertain places and share prices are volatile as a result. Deal with it; there is little to be gained in lamenting that which we cannot change. But why get hung up on trying to correctly anticipate exact share price movements, especially in the short term? Isn’t it enough to know that over the long term good quality businesses will, on average, provide a decent and regular return, most likely above that of the other asset classes? Regardless of the occasional (and indeed inevitable) recession and bear market.
Sitting on the sidelines may sound like a sensible thing to do, but there is danger in waiting for certainty to return. You could be waiting a long, long time!
If you want to get serious about wealth creation and are sick of all the stress and effort of more active strategies, check out the DividendKey. It will be the best investment you ever make.
Make the markets work for you
Andrew Page
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