Saturday, February 13, 2016

Meet Your New (Slightly Neurotic) Little Buddy - Mr. Market

What's up with the Stock Market?  Sometimes it's better to not pay attention.

The markets have been a bit of a roller coaster latelya mostly down roller coaster. The S&P 500 is down about 9% so far this year to follow what was a sideways 2015 (I say sideways as you lost a bit on the index but made that back in dividends, so net-net you came out roughly even.)

So are we in for another 2008-09 market slide and recession? The Unrepentant Capitalist doesn't think so.  As far as the market goes, we haven't had the excessive valuations, heavy doses of indiscriminate retail investor buying, and frenzied activity in M&A and IPOs that typically precedes a crash.  Our economy seems to be stuck in low gear with a 2% growth rate, but the consumer is in pretty good shape as the typical household balance sheet is healthy, the savings rate is relatively strong, and job creation and unemployment are decent.

The market seems to be preoccupied with a few things, the Federal Reserve's next move, the price of oil, and China.  

The Fed raised its Fed Funds rate a quarter point in December and, more importantly, hinted to as many as four more hikes in 2016.  Four seems way high, and Yellen et. al. have said future hikes will be 'data driven' meaning they'll take the larger economic picture into consideration. That sounds like one hike in 2016 to me.

Since I was a kid, I've been hearing how we're going run out of oil someday.  Here I am an adult, and that day feels like it's a long ways off.  BP's CEO recently said "we've got so much oil that were running out of places to keep it....pretty soon we'll be filling every swimming pool in Texas to store it all."  The story I keep hearing is that the Saudi's are pumping like crazy so they can drive the world's marginal producers out of business.  They're putting quite a strain our domestic producers (and the debt holders of those producers) and driving the Russians to the wall and Venezuelans to bankruptcy.  While low oil prices are hurting some, others are benefitting.  The consumer, the airlines, and other transportation companies are spending less on fuel and able to spend more elsewhere.  

So what about China?  It's hard to know what's really happening there as their government routinely cooks the books, but they're obviously slowing down.  How much is their slowdown going to impact us?  I think the impact will be more indirect as they don't buy much from us directly.  The bigger hurt will be to those economies that sell the Chinese raw materials (think places like Australia and Brazil).  We'll be impacted to the extent that Brazil and the like buy less stuff from us.

So how does this Fed/Oil/China three legged stool net out?  I'm not sure, but the market is likely to stay volatile as positive and negative news continues to develop on these three fronts. If you want to sleep well at night, my advice is to not follow things too closely.  What are you saying Unrepentant Capitalist? 

In his letter to shareholders in the 1987 Berkshire Hathaway annual report, Warren Buffet describes the erratic ups and downs of market via a clever allegory he borrowed from legendary investor (and Buffet mentor) Benjamin Graham called Mr. Market.  This fictional character is a great way to think about the market especially during times of great volatility.


So, a little copy/paste from the 1987 Berkshire Hathaway annual report, and voila:

"Ben Graham, my friend and teacher, long ago described the mental attitude toward market fluctuations that I believe to be most conducive to investment success. He said that you should imagine market quotations as coming from a remarkably accommodating fellow named Mr. Market who is your partner in a private business. Without fail, Mr. Market appears daily and names a price at which he will either buy your interest or sell you his.
Even though the business that the two of you own may have economic characteristics that are stable, Mr. Market's quotations will be anything but. For, sad to say, the poor fellow has incurable emotional problems. At times he feels euphoric and can see only the favorable factors affecting the business. When in that mood, he names a very high buy-sell price because he fears that you will snap up his interest and rob him of imminent gains. At other times he is depressed and can see nothing but trouble ahead for both the business and the world. On these occasions he will name a very low price, since he is terrified that you will unload your interest on him.
Mr. Market has another endearing characteristic: He doesn't mind being ignored. If his quotation is uninteresting to you today, he will be back with a new one tomorrow. Transactions are strictly at your option. Under these conditions, the more manic-depressive his behavior, the better for you.
But, like Cinderella at the ball, you must heed one warning or everything will turn into pumpkins and mice: Mr. Market is there to serve you, not to guide you. It is his pocketbook, not his wisdom, that you will find useful. If he shows up some day in a particularly foolish mood, you are free to ignore him or to take advantage of him, but it will be disastrous if you fall under his influence. Indeed, if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game. As they say in poker, "If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy.
...[A]n investor will succeed by coupling good business judgment with an ability to insulate his thoughts and behavior from the super-contagious emotions that swirl about the marketplace. In my own efforts to stay insulated, I have found it highly useful to keep Ben's Mr. Market concept firmly in mind."

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