By MoneyMorning.com.au
Last night’s market action in the US just goes to show why it’s so important right now for you to base your investment decisions on sound principles.
The Dow Jones Industrials fell more than 200 points in the first hour after the open. At 3:18 pm it was still down 212 points. It finished the day up 152 points from the open… a 364-point turnaround.
And why did the markets rally?
On a rumour. A report in the Financial Times that EU commissioner for economic affairs, Olli Rehn said…
‘Capital positions of European banks must be reinforced to provide additional safety margins and thus reduce uncertainty… This should be regarded as an integral part of the EU’s comprehensive strategy to restore confidence and overcome the crisis.’
Capital positions must be reinforced? This should be regarded as integral? So nothing happened. The FT said ‘jump’ and Mr Market said, ‘how high?’ And investors piled into stocks, like JP Morgan Chase [NYSE:JPM], which rallied 12% in the last half hour of trade.
It’s almost impossible to trade a rumour-driven market like this. It just rises and falls with the headlines. Yet, somehow, the New York Stock Exchange volatility index fell 10.25% last night.
Luckily, it’s always possible for you to find sound businesses trading at a discount to value – whether we’re in the depths of a depression of the height of a bull market.
If you use rational judgment to arrive at a company’s intrinsic value you can make profitable investment decisions in any market.
Mr Market will offer to buy or sell your shares for a different price each day. But his offer is not based on a rational appraisal of a business’s value. It is based on emotion. Most people don’t realise this and take the offer at face value.
But value investors know Mr Market’s offers change daily. And they only have a passing resemblance to a company’s true value – especially in a market distorted by past and expected future monetary interventions.
These distortions are the cause of the current volatility. This type of environment is not likely to end anytime soon. But you must not let it take advantage of you. Consider these quotes from the author of The Intelligent Investor, Ben Graham:
‘The true investor scarcely ever is forced to sell his shares, and at all other times he is free to disregard the current price quotation. He need pay attention to it and act upon it only to the extent that it suits his book, and no more.’
‘Thus the investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage. That man would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other persons’ mistakes of judgement.’
This was first written in 1949, when the stock market was a male dominated world – hence the references to ‘him’ and ‘his’.
When it comes to central bank intervention, one of the biggest impacts is on ‘liquidity’. But that is no reason to run out and speculate the stock prices will move higher.
‘…what this liquidity really means is, first, that the investor has the benefit of the stock market’s daily and changing appraisal of his holdings, for whatever that appraisal may be worth, and, second, that the investor is able to increase or decrease his investment at the market’s daily figure – if he chooses. Thus the existence of a quoted market gives the investor certain options that he does not have if his security is unquoted. But it does not impose the current quotation on an investor who prefers to take his idea of value from some other source.’
To sum up:
‘Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.’
Greg Canavan
Money Morning Australia
Publisher’s note: Greg Canavan is the foremost authority for retail investors on value investing in Australia. He’s the former head of Australasian Research for a major asset-management group and a regular guest on CNBC, Sky Business’s ‘The Perrett Report’ and Lateline Business. Greg shares his insight, ideas and investment recommendations with readers of his Sound Money. Sound Investments newsletter… to find out more information on Greg’s letter, go here.
