“There simply is no place for certainty in fields that are influenced by psychological fluctuations, irrationality, and randomness. Politics and economics are two such fields, and investing is another.”
– Howard Marks, The Folly of Uncertainty
Last month, we gathered with some valued clients for a live discussion of our investing philosophy. This month, we explore the question of why stock prices are so much more volatile than their underlying economic fundamentals.
Great Investors Know “Certainty” Is an Illusion
Save the Date — October 17th
We have been publishing our Great Investors article series for over 10 years now, and this series has consistently been our most popular content. We thank our loyal readers, and we truly appreciate your comments and feedback over the years.
As you know, we have changed the format for our Great Investors series from a monthly written commentary to a quarterly webinar format. During these webinars, we deliver a brief talk summarizing our outlook on current events, delivered in the same style you have come to appreciate in our monthly article series. We then have ample time for Q&A and discussion to address any additional questions you may have.
Our next webinar will be held on Thursday, October 17th, and will be available via a live stream as well as in-person for those who can attend. Please save the date, and more details will be available soon!
Economic Fundamentals Are Not Volatile — People Are
Global equity markets have been experiencing a relatively smooth upward ride for most of this year, but volatility has made a comeback, thanks to some questionable economic data released during the week of July 29th.
On Thursday, August 1st, weakening employment, manufacturing, and construction figures triggered a selloff in stocks, which intensified on Friday, August 2nd, when the U.S. jobs report was weaker than expected. The S&P 500 fell by roughly 4% over just two days and then dropped another 3% on Monday the 5th, as the financial media blared headlines about “global markets in chaos!”
However, almost immediately, investors appeared to think they had overdone it and started buying stocks again. Over the next 3 days, the S&P 500 rallied back by almost 2.5%.
In all, stocks were down 7% in 3 days, then back up by 2.5% over the following 3 days. For those who pay attention to the daily gyrations of equity market prices, this volatility can seem exhausting and scary but also puzzling. How is it that so many investors seem to overreact so significantly to the news and then react again to their own overreaction, causing this rollercoaster ride in equity prices? Out of the massive ocean of economic data that is published every single month, why did these particular isolated bits of data cause such a firestorm of activity?
Fortunately, investing legend Howard Marks recently published his quarterly investor letter, which offers a brilliant explanation. Basically, Mr. Marks articulates a truth we have long believed: It is not markets or economies that are volatile — it is investor emotions that are volatile.
As Mr. Marks wrote:
“But markets swing more than [do] economies and companies. Why? Because of the importance and unpredictability of market participants’ psyches or emotions. Thanks to further help from [Brean Capital economist] Conrad DeQuadros, I can illustrate the greater variability of markets as follows:
Why is it that stock prices rise and fall so much more than the economies and companies that underlie them? And why is it that market behavior is so hard to predict and often seems unconnected to economic events and company fundamentals? The financial “sciences” — economics and finance — assume that each market participant is a homo-economicus: someone who makes rational decisions designed to maximize their self-interest. However, the crucial role played by psychology and emotion often causes this assumption to be mistaken. Investor sentiment swings a great deal, swamping the short-run influence of fundamentals. It’s for this reason that relatively few market forecasts prove correct, and fewer still are ‘right for the right reason’.”
– Howard Marks, The Folly of Certainty
Helping Those You Care About
Over the last two years, the faith of all long-term investors has been severely tested. As must happen every few years, we were basically required to do just one big thing: reject the idea that this time it’s different and hew to the belief that this too shall pass. We must not doubt that we’ll get many additional opportunities to practice patience and discipline in the years to come.
Successful investing, while always fundamentally simple, will never be easy. You may have a family member, colleague, or friend who perhaps did not fare as well during the 2022-23 bear market and who you feel might have benefited from the sort of advice you were receiving. Should that be the case, we would certainly appreciate your introducing us to them. We very much enjoy working with you and would welcome the opportunity to offer the same level of planning and service to people whom you care about.
You are more than welcome to bring a friend or family member to our event on October 17th or to share the recording of our discussion that night. A friend of yours is a friend of ours.