Trying to make sense of the stock market today
Posted by John T. Reed on
What do I think about the recent drops in the S&P 500 and the FAANG stocks?
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I know nothing about short-term stock price movements. Neither does anyone else. Those who say they do are lying or, if they are sincere, mistaken.
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I like the logic of Ben Graham’s value approach based on fundamentals like return on equity and price/earnings ratio. But I hasten to add that Graham himself lost something like 60% of his stock equity during the Great Depression when he was investing according to his fundamental value theory.
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My belief is that sometimes the market is in a period of irrational exuberance, sometimes in a period of irrational despair, and sometimes neither of those. In that latter period, I suspect Graham’s theory is valid. The Great Depression stock crash was in part a correction from a period of irrational exuberance (Roaring Twenties) followed buy irrational despair.
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At present, a number of stocks are irrationally overvalued like Tesla and Amazon. Those ought to be falling. But many others, including Apple, have a reasonable PE ratio of 19.37. Alphabet (Google) is at 23 which a bit high but Google is extremely profitable. Ditto Facebook at 20.
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Seems to me that Ben Graham’s fundamentals are pretty good now at most publicly traded companies. If that is the case, much of the recent fall is irrational despair. But as the Depression showed, and economists John Maynard Keynes may have said, “The market can remain irrational longer than you can remain solvent.”
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So the market currently seems to be wrong. But, by definition, the market cannot be wrong about market value because the market’s opinion is the price at which you have to buy and sell. It’s like the “infallibility” of the Pope on some issues. Basically, on those issues, his word is law. And the market price of stocks the only price at which you can sell.
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So stock market buyers implicitly say today, yes, the market is currently wrong, but it is a good time to buy because the market will soon wise up. If it is not soon, then maybe those who buy now are the ones who will be proven “wrong” in the sense that only buying when the market is wrong and the market is about to wise up is profitable. If they market stays “wrong” after you buy, you lose or fail to make adequate profit.
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You probably should own stock for diversification purposes, but you probably also should follow Graham’s model supplemented by the need to have both psychological and financial patience. By financial patience I mean, you must have enough liquidity to pay your routine and expected non-routine debts—like replacing a car or roof—while you are waiting for the market to come back.
.
During the Great Depression, lots of people figured out that buying at the bottom was a great idea, but they lacked either the courage or the cash to actually do it. Stock prices fell 89% from 1929 to 1932. They eventually came back but it took about 30 years.
.
I know nothing about short-term stock price movements. Neither does anyone else. Those who say they do are lying or, if they are sincere, mistaken.
.
I like the logic of Ben Graham’s value approach based on fundamentals like return on equity and price/earnings ratio. But I hasten to add that Graham himself lost something like 60% of his stock equity during the Great Depression when he was investing according to his fundamental value theory.
.
My belief is that sometimes the market is in a period of irrational exuberance, sometimes in a period of irrational despair, and sometimes neither of those. In that latter period, I suspect Graham’s theory is valid. The Great Depression stock crash was in part a correction from a period of irrational exuberance (Roaring Twenties) followed buy irrational despair.
.
At present, a number of stocks are irrationally overvalued like Tesla and Amazon. Those ought to be falling. But many others, including Apple, have a reasonable PE ratio of 19.37. Alphabet (Google) is at 23 which a bit high but Google is extremely profitable. Ditto Facebook at 20.
.
Seems to me that Ben Graham’s fundamentals are pretty good now at most publicly traded companies. If that is the case, much of the recent fall is irrational despair. But as the Depression showed, and economists John Maynard Keynes may have said, “The market can remain irrational longer than you can remain solvent.”
.
So the market currently seems to be wrong. But, by definition, the market cannot be wrong about market value because the market’s opinion is the price at which you have to buy and sell. It’s like the “infallibility” of the Pope on some issues. Basically, on those issues, his word is law. And the market price of stocks the only price at which you can sell.
.
So stock market buyers implicitly say today, yes, the market is currently wrong, but it is a good time to buy because the market will soon wise up. If it is not soon, then maybe those who buy now are the ones who will be proven “wrong” in the sense that only buying when the market is wrong and the market is about to wise up is profitable. If they market stays “wrong” after you buy, you lose or fail to make adequate profit.
.
You probably should own stock for diversification purposes, but you probably also should follow Graham’s model supplemented by the need to have both psychological and financial patience. By financial patience I mean, you must have enough liquidity to pay your routine and expected non-routine debts—like replacing a car or roof—while you are waiting for the market to come back.
.
During the Great Depression, lots of people figured out that buying at the bottom was a great idea, but they lacked either the courage or the cash to actually do it. Stock prices fell 89% from 1929 to 1932. They eventually came back but it took about 30 years.
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