The joy of not checking stock prices

I recently finished a wonderful book by Guy Spier, The Education of a Value Investor. In it, he spells out his own history as a value investor and highlights some of the ways he has set up his investing environment to make success more likely.

One of his best suggestions is to check stock prices as infrequently as possible.

This may sound like¬†sacrilege¬†to both professional and layman investors. “How can you react to the market’s ebbs and flows if you aren’t watching prices all the time?”

The answer is: you shouldn’t be reacting to the ebb and flow of prices. A focus on prices going up and down is a distraction to understanding businesses at a fundamental level. Only after you understand a business thoroughly–it’s competition, buyers, suppliers, management, potential rivals, possible substitutes–and have figured out what you think a business is worth should you look at the price.

I must admit, I have fallen into the trap of looking at stock prices too frequently. Doing so is very distracting. Instead of focusing on understanding a business and its value, you get dragged into looking at the stock price and begin to impart interpretations into why the price has gone down or up. Every moment spent trying to understand those senseless moves are moments not spent understanding the business.

I have gone the last two weeks without checking stock prices. That doesn’t mean I don’t have mechanisms set up to react to low or high prices on businesses I already understand, it just means I don’t look at daily price moves and how they compare to the market that day. The result is that I’ve gotten more fundamental research done and I feel more sober-minded in trying to understand the businesses I’m researching.

In time, I believe I’ll also have better investment returns to show for it.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Advertisements
The joy of not checking stock prices

Recession storm-clouds gathering

Although the latest GDP report showed the US economy grew at a blazing 4.9% in the 3rd quarter, the data looking forward is looking increasingly weak.

The Index of Leading Economic Indicators (LEI) has gone into negative territory. Our economy has gone into a recession every time the LEI has gone negative, except for once in the late 1960’s.

The credit crunch, brought on by lax lending standards to subprime borrowers, is spreading to every credit market. Banks are taking HUGE write-offs, and being forced to make fewer loans as they rebuild their balance sheets.

The employment market looks to be rolling over. The four-week moving average of initial jobless claims has risen to 343,000, the highest since June 2004 (except for the spike due to Hurricane Katrina). In June 2004, it was on the way down after the 2001 recession. It’s currently on the way up.

Retail sales are looking to be worse Christmas season since the last recession.

Volatility in the bond and stock market has risen dramatically.

Copper prices have been falling.

UPS and Fedex have announced disappointing results looking forward, and the Dow Jones Transportation Average has been diving.

Financial indexes have been tanking, and in a finance-based economy like ours, that’s a bad sign.

The one big thing that hasn’t confirmed all these dark clouds is the stock market. Either stock investors are more prescient and no recession will occur, or they are deluding themselves into believing things will be okay or the recession won’t last long.

My guess is that most stock investors are being overly optimistic, and aren’t looking at coming earnings shortfalls.

When companies begin to report earnings next January, I think investors will get an initial shock. Over time, more information will pour out that the economy is in a recession. By the time this evidence is conclusive, the economy will probably be recovering.

Most investors will be scared when they should be greedy. In other words, by the time investors are scared about a recession, stock prices will be low, and it will be a great time to invest.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Social influence plays a big part in outcomes

The success or failure of a venture can be greatly influenced by the early reactions of people.

This statement may seem obvious to you, but a recent academic study recently showed just how important initial reactions can be on success or failure.

I read about the study in Michael Mauboussin’s recent Legg Mason article. Three Columbia University sociology researchers set up a website where people could download music. 20% of the people who went to the website were provided with no information about what others had downloaded. Another 8 groups (10% each) were formed which could see download rankings.

The study showed that top songs tended to finish in the top, and bottom songs tended to finish at the bottom regardless of whether download rankings were available. But, the vast majority of songs in the middle were ranked very differently depending on whether people could see download frequency.

In fact, the study showed that once 1/3 of the participants had downloaded songs, the next 2/3 of people followed their lead. This lead to very different outcomes between the 8 groups who could see download frequency.

In other words, the intrinsic quality of songs was trumped by the cumulative advantage of social influence for the vast majority of songs. Songs downloaded frequently by a group were then downloaded more frequently by others, creating cumulative advantage.

This may seem obvious when you think about Betamax versus VHS digital video tapes, or Apple versus Microsoft Windows, or, more recently, iPod versus any other MP3 player.

The same is undoubtedly true for picking investments. In the short term, people pile into the same investments that everyone else is talking about, regardless of the intrinsic value of the underlying business.

Luckily, the market has the benefit of quarterly and annual earnings reports, which force stock prices to track with underlying value over the fullness of time.

This doesn’t mean that stock prices are always right–quite the opposite.

Don’t judge an investment by what it’s stock does over the short term if you’re a long term investor. Otherwise, you may suffer from the social influence of following the crowd.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.

Interest rates

For those of you not paying attention, the bond market has had an amazing month and a half!

If you are thinking to yourself, “What does the bond market have to do with anything, I buy stocks,” hold on to your hat.

Bonds are frequently used as the discount rate or the base rate from which discount rates on stocks are computed. This is most prevalently seen in the Fed Model, but is also the way almost every finance textbook used in business school starts.

If bonds drop in price, and their yields go up (as has happened lately), then stock prices should go down (all things being equal, and they never are). By how much? I’ll get to that below.

Back on May 2nd, the 10 year yield on US Treasury bonds was 4.64% and the 3 month yield on US Treasury bills was 4.87% (according to Value Line’s May 11 Selection and Opinion). Today, according to PIMCO’s website, the 10 year is yielding 5.30% and the 3 month is yielding 4.72%.

This is a massive change! The 10 year’s yield jumped 0.66% and the 3 month’s yield dove 0.15%. Because the bond market has such a huge impact on all discount rates in the market, this is a huge change!

For those of you thinking the stock market’s recent sell off has taken account of such a discount rate change, think again. The DJIA was at $13,211.88 on May 2nd and closed at $13,295.01 today, a 0.63% increase. All things being equal (assuming estimates on company earnings haven’t changed), the DJIA should be at $11,566.60–down 12.45%! Instead, it’s at $13,295.01, implying that earnings estimates for the DJIA have increased by 14.95% in the past month? I doubt that.

I’m NOT suggesting the Fed Model is correct or that stock prices should move precisely with bond yields, but I am suggesting that the stock market, and perhaps other markets, have not taken full account of recent bond price and yield movements.

Also, how do you think bond price moves will impact mortgage and housing markets? A 30 year mortgage on a $300,000 house should go up around 7% per month (or $130) based on this bond price change. Does it seem like that’s been figured into market prices for home builders and mortgage companies? It doesn’t seem like it to me.

As usual, I’m making no assumptions about what will happen in the market and when, but I do find recent bond market moves disturbing.

Perhaps bond prices and yields will go back to where they were, vindicating recent stock market moves. Perhaps fundamentals are improving just as quickly as bond prices are dropping and this justifies no move in prices.

I can’t predict what will happen much better than the next guy, but I am scratching my head and wondering what other people in the market are thinking.

Nothing in this blog should be considered investment, financial, tax, or legal advice. The opinions, estimates and projections contained herein are subject to change without notice. Information throughout this blog has been obtained from sources believed to be accurate and reliable, but such accuracy cannot be guaranteed.