The wild volatility of last week was a stark reminder that, even after two years of bull market gains, the stock market is indeed risky. You can make a fortune quickly, only to see it slip away even quicker.
Plenty of writers before me have compared the market to a casino, and there is a lot of truth in the comparison. The purpose of stock markets is ostensibly to provide a means for existing stockholders to find buyers to whom to sell their stocks, which lowers the cost of capital and allocates it more efficiently.
But, as Warren Buffett has pointed out, if the allocation of capital were the only motive, it would be perfectly acceptable to have all orders cleared once per day or even once per week. Investors legitimately wanting to own a piece of, say, Wal-Mart or IBM, do not need instant execution or around-the-clock trading. Having a continuous liquid market merely encourages speculation and a gambler’s mentality. (For an excellent explanation of the market’s casino roots, I recommend you pick up a copy of Aaron Brown’s The Poker Face of Wall Street. Brown should know; in addition to being the former head of Morgan Stanley’s risk management, he is also quite the Texas Hold ‘Em poker player.)
Lest it sound like I am moralizing, I don’t necessarily mind that the market is designed to be a casino. Gamblers are prone to destructive, risk-seeking behavior and emotional instability. If, like Mr. Buffett and other great investors, you are able to keep a level head, you can use this to your advantage.
In The Intelligent Investor—Benjamin Graham’s 1949 classic still considered by many to be the best book on investing ever written—Graham tells the parable of Mr. Market. In Graham’s story, Mr. Market is your business partner, and every morning he offers to buy your interest in the company or to sell you his. Most days, his offer is reasonable and fair, but Mr. Market is prone to wild mood swings.
Some days, Mr. Market is bursting with enthusiasm and offers to buy your share for an absurdly inflated price. Other days, Mr. Market is overcome by fear and offers to sell you his half of the business for the change in your pocket. An intelligent investor is only too happy to oblige the unfortunate Mr. Market, buying from him when he panics and selling to him when he is insufferably confident.
This story has been repeated in so many places it has become something of a cliché, but it bears revisiting at times like these. I believe that the recent sell-off has created a good, contrarian buying opportunity, particularly for the stocks covered in The Sizemore Investment Letter. Let’s take a step back and look at the facts:
- Stocks in the United States and Europe remain very reasonably priced by historical standards. The trailing price / earnings ratio of the S&P 500 is 13. The Dow’s is even lower at 12.
- The Fed’s monetary policy remains very accommodative and interest rates across the yield curve remain at or near all-time lows.
- The prices of competing investments — such as bonds and commodities — appear to be quite expensive by comparison.
- The macro themes we’ve been covering most thoroughly in recent months — particularly the New American Baby Boom and the rise of the Emerging Market Consumer — remain intact. American births are still near all-time highs, meaning that demand for baby and child-related retail will not be abating any time soon. Likewise, modern consumer culture continues to flourish in emerging markets such as China, India, Turkey, and Brazil.
To be sure, there is no shortage of macro concerns to worry about. The debt ceiling fiasco took us a lot closer than it should have to national default. The sovereign debt crisis continues to fester in Europe with no end in sight. And most critically in the recent sell-off, it now appears that the economy is markedly slowing down and that a new recession is a real possibility.
I take these issues seriously, of course. But let’s look at them a little deeper. The debt ceiling incident was an embarrassment, but at no point did anyone seriously doubt the country’s ability to pay its debts. The issue was its willingness to do so.
In Europe, Spain is widely feared to be the next dominos to fall. I remain skeptical of this fear. While Spain had (and still has) some of the most inflated home prices and at-risk banks, the country’s national debt is surprisingly low. By the IMF’s measures, Spain is the 27th-most-indebted country in the world as ranked by debt-to-GDP. This puts it below France, Germany, the Netherlands, and Britain, among others. It is adding to that debt at an alarming rate due to its yawning budget deficits, high unemployment, and decimated housing market, but the country is (belatedly) taking the crisis seriously and is reining in its public spending. With an election scheduled for November, there is some amount of political risk. But overall Spain’s situation would appear to be manageable, though not particularly enviable. Spain is not Greece.
As for the risk of recession, the preoccupation with this is something I have never understood. By the time a recession is officially declared, it is usually close to being over. Its damage has already been done, and its effects long ago already factored into stock prices. Granted, we live in extraordinary times. That the Great Recession was not even worse was due to unprecedented fiscal and monetary stimulus from Washington—stimulus that is now politically unpopular.
If you can stomach the volatility, I recommend that you continue to hold your stock positions and even add to them if you have idle cash. By all means, use the recent volatility as an opportunity to sell some lagging positions and reallocate to your stronger holdings. But don’t panic and sell at exactly the moment you should be buying.
Charles Lewis Sizemore, CFA is the editor of the Sizemore Investment Letter, and the chief investment officer of investments firm Sizemore Capital Management. Sign up for a FREE copy of his newest Special Report: “3 Safe Emerging Market Stocks for a Shaky Market.”
