I feel like I witnessed a sadly common investor behavior tragedy over the last several weeks. Markets kept going up in April for a variety of reasons. In my opinion, probably the primary reason is that people started getting nervous that the market was going up without them. They started trying to figure out why that was. The pressure was on to find out why, which essentially became an attempt to figure out a reason to justify buying in after the rise. Psychologists call this “confirmation bias” thinking. We started hearing about ‘green shoots’ in the market, how cheap cyclical stocks were, and how somehow the trade wars would end positively. Around the beginning of May, we seemed to hit the peak of the fear of missing the move. Cyclical stocks, like tech, financials, and industrials, seemed to hit peaks as people gave up their caution and invested in stocks that might catch them up to the market. That, of course, now appears to be the most recent peak, particularly for those stocks. The people who got nervous and started chasing are now likely even further behind.
What’s going on there? There are a variety of problems, but I think the most basic problem is how hard it is not to focus on the last price. If tech stocks are soaring, well, that’s what happened, and the natural tendency is to think that’s what will continue to happen. After all, people sure seemed excited about them, so good things must be happening. How do you get away from that? You need a different lens. Using the last price to determine your expectation for future price is a great way to chase performance and lose, like we’ve seen in May.
For my part, I focus on macro and fundamentals. What’s the likelihood that economic growth is going to get better than it has been over the last year or three? As my previous blog talked about (As Good as It Gets?, April 16, 2019), the chances of seeing better economic data anytime soon is vanishingly small. It’s the same deal with fundamental corporate earnings growth. It’s clear to me we’re not going to get close to the profit growth we saw in the middle of last year.
That said, people are still pricing in great scenarios. Instead of getting excited about that, I recommend you look at it like Warren Buffet looks at Mr. Market. Some guy (the market) is offering you prime prices to sell, as he’s excited about the market. Instead of focusing on price, you can use your different lenses of macro and fundamentals to decide how the market really looks. Right now, what you see doesn’t look very good, so you can hit Mr. Market’s bid with some confidence.
That’s basically what we did towards the beginning of May. We looked at the market getting excited, considered the reasons, and looked at scenarios that would justify the prices of popular cyclical stocks. Because of earlier por=olio positioning, we didn’t have much that we felt the need to sell, but looking at macro and fundamentals, that’s what we ended up thinking about. There was no good justification for the popular stock prices, except perhaps for the potential of very short term positives like a potential trade deal.
Price is a powerful signal for many investors. A higher price is the end product of what we’re looking to get. The problem is, because of that, price has an outsize effect on our feelings. We look at a price, and tend to think it will continue trending the same way. There has to be something right or wrong to set that price, right? If the stock has done poorly, there must be something really wrong with it, and if the stock is up they must be hitting on all cylinders. Instead of focusing on the price to determine what you think of the future potential of a stock, I’d focus on something else. The past is not the future, much as investors tend to feel that way. For my part, looking at macro, fundamentals, and the various scenarios (green shoots, trade wars, etc.) that can impact those two provides a better, if more complex, backdrop to determine how to react to price. One of the basic problems is that risk can act like an earthquake. You get little tremors, then everything seems fine again. Then you get more shakes and things settle again. Then you get a massive earthquake. If all you focus on is those little tremors, you stand a decent chance of being in the way of danger when the big one comes. Similarly, if all you do is dismiss those little price changes, you’ll probably still be there for big price changes. With a focus on something other than price, you can be better prepared.