Turmoil. An investor asked me if I was concerned about the “turmoil in Washington” and its effect on markets. I asked him, “When hasn’t there been turmoil in Washington?” Or in the Middle East…North Korea…Russia…Venezuela…you get the picture.
It’s a fair question he asked. And if your investment strategy is to try and guess…predict…forecast…how the market might react to turmoil, then I suppose you would have a lot to think about. Acting on this is a whole other matter. Because there are others like you out there. They are contemplating changes to their strategy based on this same turmoil and this is why the markets price in the turmoil so quickly.
So then you might try to second guess those other market participants. Try and be two steps ahead of them. Ah, but they are thinking the same thing, aren’t’ they. This might be but one reason of many why markets sometimes react quite differently than we expect to turmoil or a news event. Thousands upon thousands of market participants trying to outguess each other as to how markets might react.
You may believe the market will drop based on some event; but it will happen quickly so you wait for the drop as an opportunity to buy this “correction”; others feel the same way and rush in when said drop doesn’t occur! And so an event you think will cause a drop in the market has the opposite effect. This happens all…the…time…
James Surowiecki wrote a book called The Wisdom of Crowds. There’s some fascinating stuff in there, mainly about how individuals within very large groups have bits of information that taken by themselves might have little value. But when aggregated with the rest of those who make up the large group, becomes valuable information. He writes of the great statistician, Francis Galton, who in 1906 observed the weight guessing competition of an ox at a country fair. He discovered that the average guess (1197 lbs) was nearly spot on (1198 lbs). Eight hundred people entered the competition. This is applicable to open markets with a great many participants like the stock market. No one investor can consistently tell us exactly what a company is worth but the aggregate opinions of thousands of investors is usually the best valuation. So the best estimate of the value of a company is its stocks price! Stating that the stock is overvalued or undervalued is an exercise in egotism. You think you know more than the rest of investors in the market. Lesson: no one participant is smarter than the aggregate intelligence of all participants.
It’s foolish to try and outguess the crowd because there’s ample empirical evidence that markets work quite well. Do they sometimes go haywire? Sure, so invest patiently and stay disciplined.