During the current Covid-19 outbreak in the last three months, we have observed investors continue to make many common mistakes in investing. We cannot help but notice that human nature have not changed much in past decades. The same mistakes are being made over and over again by investors. Here we discuss and elaborate on five of them.
Selling stocks after reading negative headline news in the media
Recently, many investors have turned bearish on the overall stock market and feel that the recent market rebound is unjustified given the economic recession that we are experiencing now. Because these views are so commonly shared, we believe that they are misguided for several reasons.
The world of short-term stock trading is an ultra-competitive one. We live in the age of computer trading where hedge funds employ AI to scour the internet, newswire and proprietary database in real-time, figure out the nature of the new information and then trade stocks automatically in seconds. Our stock market is especially efficient in reflecting macro and geopolitical headline news as they are reported in the internet media. By the time a human reads and digests a piece of news, it is already too late to react as stock prices have already moved to reflect the new information hours before. Human beings simply cannot compete with computers in reacting quickly to these continuous headline news flow.
Our stock market operates like a pari-mutuel betting system similar to horse race betting. All bets go into one pool so the price of any given security incorporates the opinions of all market participants at a given point in time. When an investor develops a bullish/bearish view on the overall market, one always has to ask what information he/she possesses that the market does not already know.
Furthermore, the valuation of any asset depends on its future earning/cash flow over the next 1, 5, 10, 20 years up to infinity discounted at the current interest rate. Therefore, we believe that 1-2 years of earning/loss only have 10-15% impact on the value of a stock. As such, selling a stock of a high quality business after an 30% decline due to one or two years of anticipated poor earnings is indeed an unwise move.
Mixing up the US financial market with the US economy
Some investors think that if the US economy is expected to collapse, then one should not invest funds or assets available in the US financial market. The fact is that US market is a global financial supermarket where one can buy both local and imported assets.
At the asset class level, one can buy commodity, global real estate, bond, currency, derivative assets in form of a fund. The US market carries the broadest and lowest cost selection of inverse index and options products for those who need to hedge their downside risks. At the country level, one can buy assets in any country including Vietnam, Japanese, French or Australian stocks in form of a fund. At the company level, one can buy Chinese (Baidu and Netease) and Brazilian (Mercado Libre and Stone Co.) equities in the US that are not even available back in their home country. Within US S&P 500 index companies, only 55-60% of their overall revenue comes from the US.
As the most developed financial market, the US has the best selection of global financial assets and their products often carry the lowest management/transaction fee. Smart investors shop for global assets in the US financial supermarket for the best price, selection and liquidity.
Trying to make market forecast by the month or year
People love reading about stock market forecasts and the media/brokers love offering them as they make a good living out of it. However, it is unlikely that any accurate market forecaster would broadcast his/her prediction in the media. He/she would more likely be trading on his/her own account and enjoying a good life hidden from the limelight. Only so-so market forecasters who cannot make a living by trading would go through the hassle of appearing in the media and keeping a full-time job as a market commentator/stockbroker.
We should accept the reality that the short-term stock market movement is always unpredictable as: 1) financial markets are driven by humans and our collective emotional swing and psychology are the most difficult thing to predict in the universe; No one can guarantee that market participants will act rationally at all times; 2) Unpredictable shock events like natural disaster and exogenous incidents like pandemics have and will continue to occur. No one has the crystal ball.
While monthly market movement matters a lot to some hedge funds that promise investors to make money in any markets, it should matter very little to most other investors like individuals saving for retirement, pension and endowment. Most institutional investors recognize that recession, natural disaster, human conflicts are just part of human civilization and will continue to happen. Based on the last 100 years of stock market history, we know that if our investment horizon is long enough (10+ years) and if we stick with a well-diversified investment portfolio, return will almost always be favorable. For both stocks and real estate investments, time in the market is more important than timing the market.
Looking at the price chart to guide investment decisions
Many investors look at price chart and past performance of a stock/index to guide them in investment decisions. It is because these charts are always the most easily accessible information about an investment. However, in this case, we believe that the easy thing to do is exactly the wrong thing to do. When we buy any item whether it is a stock or an orange, we try to evaluate its quality first, then we look at the price. One cannot determine an item’s value by just looking at its price.
Furthermore, in the investment world, a good asset will become a bad investment if price increases far enough to exceed its value. There is NO asset that is always a good investment regardless of its price. Buffett once said that there are three ‘I’s in every market cycle. The ‘innovator,’ that’s the first ‘I.’ After the innovator comes the ‘imitator.’ And after the imitator in the cycle comes the idiot. When we look at any market that has done well recently and where bullishness is prevalent. We become skeptical wondering whether we may be the idiot of the cycle as the last person holding an asset when the music stops. A flipping investment strategy is always risky as it depends on the kindness or generosity of strangers. Any consensus buy idea that has done well enough will ultimately become a sell idea as everyone that favors it has already bought and there is no more new buyer left.
Believing that bond and real estate are less volatile and are therefore better investments than stocks
Many investors believe that bond and real estate are less volatile and therefore better investment than stocks. We believe whether an investment is good or not depend on the price you pay for it, not its daily price volatility. In today’s bond market, we see a lot of over-priced assets that pay a low fixed coupon for 10 plus years with no upside and inflation protection. In the real estate market, we see a lot of over-priced assets in major metropolitan areas where the rental yield is very low.
By nature, real estate have low liquidity and does not have a daily price quote. The lack of daily price quote does not mean real estate is safer and better investment. On the other hand, stocks have daily price quotes that fluctuate wildly. We believe that this volatility only reflects the emotional nature of human beings who trade them daily, not the “riskiness” of the stocks as an investment.
We think the easiest solution is to fight investors’ stock market volatility panic syndrome is to try to ignore the daily stock price quote. In most trading days, stock prices are set by 0.5-2% of shareholders and they certainly do not represent the views of the other 98% of shareholders. We recommend long term investors only look at their brokerage statement once a quarter or once a year to avoid unnecessary panic from market price volatility.
The Bottom Line
One of the main barriers to long-term success for many investors is their own psychology. It is not about financial market knowledge or stock picking. In a volatile market, your greatest enemy is yourself.