Musings on Markets Mon, 16 Mar 2020 12:00:00 GMT language
- Incremental Information versus Fundamental Information: If pricing is driven by mood and momentum, those forces can take information that, at least at first sight, seems insignificant, from a value perspective, and cause price changes that are disproportional. Thus, when the mood is upbeat, small pieces of good news can result in big jumps in stock prices, but if that mood turns sour, small pieces of bad news can cause large drops in stock prices. To illustrate, the 10% plus drop in US stocks on Thursday (3/12) was supposedly caused by the Trump Administration's decision to bar flights from Europe for thirty days, and the almost equivalent jump the next day (3/13) by its decision to declare an emergency.
- Reactive versus Proactive: Since pricing is determined entirely be demand and supply, and there is no value center to it, it is, by its very nature, reactive. Put simply, traders react to the incremental information to adjust the price, and put little thought into whether the starting price itself has a basis to it. Thus, a starting price that is too high (low) will only get higher (lower), if the incremental news that comes out is good (bad). On the other hand, value is driven by expectations of cash flows, growth and risk, and incremental information has to be used to reassess those expectations, a more difficult task, but one that forces you to separate the wheat from the chaff.
- Income Predictability: If you are feeling a little less secure about your income prospects after the last three weeks, you are not alone, and while this will pass, it does affect how much cash you need to conserve, just in case.
- Cash Needs: Virus or no virus, house payments have to be made, credit card bills paid and unexpected costs covered, and a shakier economy make all of these obligations more onerous.
- Personal make up: I believe that the key to picking an investment philosophy that is right for you is to make sure that you can pass the sleep test, with it. Put simply, if you lie awake at night thinking about your portfolio, you’ve failed the test. If you are naturally impatient, your time horizon is shortened, and no lecture on the importance of long term investing or data backing up that it works, can change that.
- As an investor, your skills may lie in assessing the entire market, sectors or individual stocks, and this crisis has brought those all into sharper focus.
- As a trader, you can be good at riding momentum or detecting shifts in it and making money from reversals, and the opportunities for both have expanded, as market volatility has expanded.
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- If you believe that markets have over reacted, your best chance at finding value might be to look in the rubble, the worst affected regions, sectors and companies
- If you think that markets have not fully incorporated the economic damage from the virus, you should look at the regions, sectors and companies that are more protected.