Beyond The Headlines

Is The Market Wrong?

October 25, 2022 | Diandra Ramsammy

A stock investor friend asked me that recently. There is much more to it than a simple yes or no answer. He wasn’t looking for a simple answer but wanted to spark an interesting conversation. I did my best to answer it, and here is what I said.

I assume the question refers to the US stock market. The S&P 500, a commonly used index that contains 503 stocks of large-cap companies traded on the American stock exchanges, has been down 30%+ in the first half of 2020, up 100% right after, down 25% since then (Source: Bloomberg). So, it’s not 500 stocks in the index, but 503, and these are US-listed companies but not necessarily US headquartered; some operate out of Ireland, Israel, Switzerland, or the Dutch Caribbean. Others might be US headquartered but generate most of their profits outside of the country. To keep it simple, let’s assume it’s the US stock market we have in mind.

When I hear a question, especially one like this one, I wonder how it came about. Anyone asking if the market is wrong hopes to be somehow “right.” It implies they are not exactly happy with the market’s “opinion.” Finally, we may enter the good vs. bad territory. Is it a good or a bad market to invest in, and if so, for whom?

What is the market anyway? We often write that the stock market is an aggregation of buyers and sellers of stocks. The ownership changes, stocks remain what they have always been, participation in real-world businesses. They have products or services; they generate sales and hopefully earn a profit.

Let’s imagine for a minute that the stock market stopped operations tomorrow, and no one could buy or sell shares, but their value would remain unchanged. You’d still hold the same percentage ownership in real business as the day before. There would be no available price quote for a moment. I say a moment because a free market economy can’t tolerate a void of that kind. The minute a buyer and seller appear, a market is reborn again, and a price gets established. The value never ceases to exist; the price might not always be available. Food for thought.

What is the stock market, though? Many have tried to capture the market as a whole and created a variety of indices. They are a peculiar invention. They don’t represent the “whole market”; they don’t even tell you the total market price of all the stocks they contain either. Taken out of context, the index level of 3,000 or 30,000 is relatively meaningless. The Dow Jones Industrial Average is almost 30,000, S&P 500 at 3,600, and Nasdaq at 10,500. Is it good or bad? Right or wrong?

The media might closely follow every downtick and uptick in the market and each stock. Even the “tick,” the smallest possible move in a security price, isn’t set in stone. Only twenty years ago, a minimum tick was 1/16th of a dollar or 6.25 cents, and it’s a cent today. Larger ticks apparently decrease trading activity and raise trading costs.

Nasdaq’s market price was around $20 trillion last year, S&P 500 $35 trillion, and The Dow Jones Industrial Average $10 trillion (Source: Wikipedia). Indices are created based on a collection of rules. They can be equal-weighted, market capitalization-weighted, the sum of the stock prices, and more. Still, whichever way they are put together, the largest index discussed above, the S&P 500, captures only about 1/3 of the market capitalization of all US publicly traded companies.

Is the market wrong? Are we implying it’s too low or too high, or maybe we are claiming that it’s “moving” in the wrong direction? Which one is right? Which one is wrong? I’m thinking of road traffic here; we seem to fall short of an agreement, too, as some grew up driving on the left, some on the right side of the road.

I’m left-handed; you could say that I’m a born contrarian, and what feels “right” to most literally feels “wrong” to me. It has proven a crucial skill and a helpful mindset in navigating the markets, though. I naturally zig when others zag. I don’t always go against the crowd, but I do prefer to have a different perspective than most.

Is this market wrong, though? The feeling that you are up “against” the market, it’s a lot like being up against the weather. It reminds me of a Scandinavian saying that there is no bad weather, just bad clothing. If it’s cold outside, you dress for it. If it’s warm, you do the opposite. If it’s a high-rising, overheated market, we act differently than when it’s a beaten-down, cooler market. In the first one, we trim, sell, and wait; in the latter, we are likely slowly or not so slowly buying up stocks.

Mr. Market allegory created by Benjamin Graham (the father of value investing, the legendary investor, and the author) sums it up best, though. He described Mr. Market as a fickle investor who goes from being pessimistic to optimistic. One day Mr. Market is desperate to sell stocks at very low prices; another day eager to buy at very high prices. Mr. Market won’t make us do anything, call us right or wrong. Mr. Market has a price to offer, and it’s up to us to decide whether we like it.

What if the market isn’t right or wrong, good or bad, it just is, and we, investors, have a choice, do we buy, sell or wait? The end goal is to grow the capital at a respectable rate over the long run without taking excessive risks. We can let Mr. Market work for us, not against us, and leave the judgments to others.

 

Happy Investing!

Bogumil Baranowski

Published: 10/25/2022

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