The stock market has rallied 12% in the past 2 days, rocketing forward on hopes that the Covid-19 crisis is shortly coming to an end and a return to normal is just around the corner.
In case it isn’t clear that is more than some investors get, as a return, in an entire year. In fact before I could finish typing this sentence the S&P 500 has dropped 1.5% during intra-day trading. Crazy!
While a return to normal is exactly what we all hope and pray for, I would like to present a rational reason why the battle to overcome Covid-19 and to get the economy back firing on all cylinders is going to be a longer road than we’ve predicted.
The explanation starts with…. Virtue. Huh? What?
At its most basic level virtue is defined as behaviour that shows the highest moral standards.
Pope Gregory defined a set of 7 moral virtues that were supposed to counter-balance the 7 deadly sins, and they were:
Faith is the belief in the right things. We need to believe in the power of humanity to come together at this difficult time. We need to hope that mankind will find a cure and persevere through the crisis by taking a positive view.
Especially as many of us are confined to our houses we need the fortitude to never give up and to keep fighting for what is right (by social isolating until such a time that it is safe not to do so).
What investors need to perhaps pay attention to is prudence and temperance.
Prudence is care and moderation with money and at a time like this it’s important that we don’t take any needless steps to either extreme (extreme frugality or extreme greed).
Temperance is the ability to abstain from things that are not needed or necessary.
What does this have to do with investing?
Let’s have a look at the behavioural elements that are apparent in one of the biggest market systems in the world: the American S&P 500 index.
As a stock index it is worth a $28.1 trillion dollars, which is more than the market capitalisation of most other countries. American business is simply colossal. The daily trading volume in the index is 5.3 billion and represents tens of millions of buy and sell positions that balance out to the market’s price, going up when there’s more buyers and down when there’s more sellers.
It is a common misconception that stocks “fall in a straight line.” The opposite is true, there’s the tug and push of buying and selling that yo-yo’s about up and down.
Here’s what that system looks like year to date:
For one thing this doesn’t represent prudence or temperance. Investors are frantically, almost feverishly trying to figure out what the direction of the stock market is going to be. That means they are selling entire portfolios one day, then buying them back the next day, with absolutely huge and unprecedented volume.
I know all of my brokers have said that demand is through the roof. It can take 40 minutes just to get through to them. Here’s proof with the daily volume this past year:
What economists, fund managers, professional financial analysts and the like are trying to get across to us is this message: calm down. The stock market could very well fall back to the previous lows it hit in March. It could continue rallying from this level (though I doubt that it will after yesterday’s monster rally!) We simply don’t have enough data yet to suggest what course is likely.
The thing that we need to practice is prudence. Stop buying into stocks on the rally – on days like yesterday where the S&P 500 index rocketed up 7%. Stop selling stocks in droves during periods like last week where the market fell 4% in a day.
Take a step back and practice the same careful, considerate investing strategy you followed before this crisis all began. Remember that? Put your free money to work – in particular – on days where the market looks weak. And leave it there.
Practice temperance by avoiding covering your perceived losses (i.e. if you have lost money in your portfolio) by taking excessive risks in things you don’t understand to try to make that money back. Perhaps consider even taking a bit of a holiday from the market and spending time with your family or friends (via Zoom or Skype of course!)
Frugal Investors Model Virtue
The reality is this: the market is irrational. In the words of Benjamin Graham, the father of modern value investing, “In the short run, the market is a voting machine – reflecting a voter registration test that requires only money, not intelligence or emotional stability – but in the long run, the market is a weighing machine.”
What this means is that the short term movement of the market is just noise and it is largely random (despite what people may try to convince you of). In the long run what matters is the tangible production of capital and the underlying businesses ability to generate cash flow for itself and its shareholders.
Hold a diversified portfolio of stocks and bonds that is appropriate for your age and risk tolerance.
Institutionalise the way that you save money and put a bit away, every month, like clockwork.
If you must invest in individual shares, as we covered in Stock Investing During Coronavirus: buy the best American businesses while they are on fire sale!