Staying Focused in Volatile Times
The past week has demonstrated one of the downsides of stocks, particularly from a risk perspective. Stocks are largely influenced by "systemic risk" or external factors, such as government actions (or shutdowns), interest rates, and other economic and political influences in the marketplace. The benefit for long-term investors, however, is that these shorter-term economic and political influences are not necessarily the determining factors on the long-term outcomes of a successful business. This is not to say that these issues are of no consequence or should be completely ignored by long-term investors, but long-term investors should primarily concentrate on business fundamentals (internal factors) rather than being swayed by shorter-term external factors.
Peter Lynch summed it up quite well: "There is always something to worry about." Thank goodness. Without the “worriers,” we would not have the benefit of short-term market irrationalities which cause the undervaluation of quality businesses. It is the actions of the "worriers" on Wall Street which provide the opportunities to pick up gems of companies at bargain prices. On the flip side, these can be the same people or forces to hype a business to a level that exceeds its intrinsic value.
I continue to reexamine and refine my investment strategy, because it is important to be able to refer to core set of investing principles when the market becomes especially volatile thanks to overplayed reactions to economic or political events. Without a consistent and principled investing strategy, external market forces will largely determine our investing decisions and we will hold little bearing over our investing decisions. Coca-Cola is a great example of a business that outlasted and even flourished in periods of the Great Depression. Investors in Coca-Cola would have been wise to focus on the fundamentals of the business even during one of the worst economic periods of the country’s history. Hindsight is 20-20, so why not try to learn from the examples of great businesses (and great investments)?
I write this partly for my own sake. In a market such as today’s, where many stocks seem to be flirting with 52-week or all-time highs, it can be easy to feel principled. However, once things turn south, it is amazing how quickly a principled strategy can be thrown to the dogs in an attempt to regain some sense of control. We live in unpredictable economic times; the government is increasingly intertwined with economic decisions and, therefore, market movements. Seven individuals, through the Federal Reserve’s Board of Governors, determine interest rate levels for the entire United States. The point is there is plenty of room for error from these bodies of consolidated political and economic power. In the short-term, stocks are largely at the mercy of these external or systematic factors. Volatility in both directions is guaranteed in the stock market.
My focus as an investor has evolved to narrow my investments to companies whose products and services I, or people around me, utilize in some shape or fashion. By focusing on investing in what you know, you can peel away the layers of external factors that cause the bulk of a stock’s short-term volatility and focus on the business behind the stock. By purchasing a stock, you are becoming an owner of a business. Why would you become an owner of a business that you do not truly understand, or whose products you or your friends don’t even use? I think it is helpful, particularly for smaller individual investors, to identify a strategy that concentrates on the business, and leave the worrying to others (there are plenty of worriers out there).
Focus on investing in businesses you understand, with products you or your friends enjoy, and of course with a sound financial and managerial situation. This approach lessens the influence of numerous external distractions on investing decisions, leaves the worrying up to professional worriers, and emphasizes a long-term outlook built upon the soundness of a business rather than the whims of short-term market forces.