The Stock Market Turbulence Trap You Should Avoid

Whenever stocks hit a speed bump, investors wonder, “Where is the market headed?” It is human nature to seek a prediction to guide our actions. But recent turbulence in the market means little – and can lead investors astray. Here’s why.

Look at April 17, when global markets wobbled with anxieties over Greece (again), corporate earnings, new trading restrictions to cool China’s hot stock market, and a technology hiccup in Bloomberg computer networks that disrupted global trading for several hours.

What does this mean to a long-term-oriented investor in the scheme of things? Nothing.

The Wall Street Journal noted the decline in the Dow Jones Industrial Average was “the biggest one-day percentage drop since March 25.” Since March 25 was only 17 trading days before April 17, the comparison was amusingly short-term. Various commentators urged investors to react to market events, to the investors’ detriment.

But listen to Lloyd Blankfein, chief executive of Goldman Sachs, who once when asked about some event and its meaning declared, “I will have a very clear answer in hindsight.”

Albert Einstein saw that at any given time the juxtaposition of myriad variables reduced forecasting to informed guesswork. “When the number of factors coming into play in a phenomenological complex is too large, scientific method in most cases fails. One need only think of the weather, in which case the prediction even for a few days ahead is impossible.”

For the long term, especially for conservative investors approaching or in retirement, a value orientation is the best approach. Value investors and value-centered money managers seek stocks of companies that they believe the market has mispriced or undervalued.

They know that the stock market overreacts to good and bad news, with herd movements that today’s high-speed trading and cheap trading costs exacerbate. This can result in stock price movements that do not correlate with the long-term fundamentals of a company. For value seekers, days like April 17 are an opportunity.

Using Einstein’s terminology, we can view the intricacies of global trading in anything – stocks, bonds, credits, commodities and currencies – as “phenomenologically complex.” A savvy money manager sees short-run volatility, on the downside in particular, not as an exercise in forecasting market direction but as a cue to determine where value exists.

A senior analyst at Brandes Investment Partners in California, a classic value manager, said in a report published before the April 17 market decline driven in part by Greek jitters, “We’re seeing attractive opportunities in Europe against the backdrop of continued concerns on euro zone economic growth as well as how Greece and its euro zone neighbors will address Greece’s sovereign debt problems.” The Brandes analyst did not offer that thought as a prediction as to market direction or an attempt at market timing, but as insight into the search for value. Widespread worries create bargains.

Source: Thinkstock

Source: Thinkstock

Value investing requires patience. During speculative market runs when investors bid up share prices of hot growth companies with no profits but a plethora of hype, value portfolios will underperform.

In his book, The Intelligent Investor, the father of value investing, Benjamin Graham, explained, “A great company is not a great investment if you pay too much for the stock … Although there are good and bad companies, there is no such thing as a good stock; there are only good stock prices, which come and go.”

Corporate profits in Europe are running about 14% below their 10-year inflation-adjusted average. On the surface, you might say, “That’s a problem.” But markets are cyclical and volatility is nothing more than movements plus and minus relative to long-term averages.

While timing can be debated, if something is below average the odds that it will revert to the mean average statistically are strong. Analysts looking for bargains in Europe or elsewhere see current low valuations and profits as providing opportunities for capital appreciation in any movement back toward mean averages.

This focus is applied to specific companies in the search for value. Global markets are dynamic and change is constant, offering pockets of value for analysts who know where and how to look.

As to the predictive value in the day after a slump, we again turn to Ben Graham, who advised, “There is a ridiculous amount of hype in the financial media. If you want to be a value investor you have to ignore basically everything they say. Here are a few examples of what to ignore: market news, market forecasts, market debates, stock predictions, buy/sell advice, any ‘hot stock’ tips.”

Rationality and patience wins in the long run.

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Lewis Walker, CFP, is president of Walker Capital Management, LCC in Peachtree Corners, Ga. Securities and certain advisory services offered through The Strategic Financial Alliance Inc. (SFA). Lewis Walker is a registered representative of The SFA, which is otherwise unaffiliated with Walker Capital Management. 770-441-2603. lewisw@theinvestmentcoach.com.

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