Panic Selling, Panic Buying
I guess I should talk about the recent market “correction.” Because even if you are well suited mentally and emotionally for it, it is still concerning. Why is it called a correction.? We may have been feeling like the market will just continue on its jolly way the rest of our lives. We know that’s not how it works. So, the gap between the feelings and reality is the “correction.” The media rarely talks about the market correcting upwards! When stocks are lower than their true value they have to correct back up also. You seldom hear pundits talking about an eminent upward correction, but in reality, panic buying is as normal as panic selling.
The idea that stocks are at some point “correct,” is odd. Why can’t they just stay correct so we wouldn’t have to fret? Unlike other assets that have a tangible mechanism to price them, stocks are driven by the whims of people all over the world who are willing to sell low and buy high. Hence the ups and downs.
The fact is, the price of stocks are rarely connected to true value. Benjamin Graham described what I will paraphrase as “The mysterious mechanism that values your stocks.” He called this “Mr. Market,” and likened it to a crazy neighbor yelling offers for your house over the fence every morning. One morning he says, “I’ll give you 800 grand for your house!” and you may think, “wow, that’s pretty good, maybe we should sell!” the next day he yells “I’ll give you $580,000 for your house!” and you think “damn, our house went down $220,000 overnight, honey, what should we do?!!” And that is very much how stock pricing works.
BUT the thing you must remember is while the stock price is rarely connected to the underlying true value, it will always follow the underlying value in the long run, just as surely as the value of your house will follow its real value, and not pay attention to your neighbor in the long run. So corrections don’t really matter in the long run since prices will chase real value.
How we determine true value can be argued, but it is always the future value of growth of earnings and dividends. And if a company is assumed to provide 12% growth in earnings and dividends, it should be priced high, low or close to true value. Commonly, the PE ratio should be near the growth rate of 12. See my blog, “How Stocks Work,” at craigverdi.com. for a more in depth look.
The stocks that are getting punished the most are the ones I thought were valued fairly in the first place, i.e. big tech companies. With a few exceptions I think they were priced about right. For instance, Google stock, which has a projected growth rate of about 22% is trading at 20 times forward earnings, meaning it has a p.e. of 20. (This is an example not a recommendation.) A better way to do it may be to buy a basket of large tech with a fund since they are almost all down, and down to a point that will create panic buying when the market quits wringing its hands.
It is notable that articles become negative, downgrades get more frequent, and chatter about risk in general all happen AFTER stock prices have gone down. The further they go down, the more negative the coverage. Of course, this is all backwards to reality. It’s always “opposite day” in financial media.
The best thing you can do, is to add cash and buy low. Buying good stocks on downturns that are low, is how a lot of money is made. This is not “timing the market,” it is reacting to something that has already happened[CV1] . Investing or selling on things you think are going to happen is timing the market. So, if you are lucky enough to add cash, you should!
Capitulation is a word we hear in this business. It is defined as the time when the last person who is going to sell, has sold. From there the market can only go up, as the sellers are all out. When that happens my name for stocks is “stupid low.” Then it is time to buy!
See you soon,