The father of value investing, Ben Graham, once said: “In the short term, the market is a voting machine. In the long term, market is a weighing machine.”
The market has been buffeted (and since we are considering value investing, that pun is most certainly intended) by macro-economic forces over the past few years and the cumulative effect has been a market which operates much more like a voting machine. For example, the 2nd quarter of 2012 was a ‘risk-off’ quarter and the markets got trounced. A few short months later, the 3rd quarter saw a complete reversal – a ‘risk-on’ quarter - and an equally sharp market recovery. Large level events continually occur through the year which could have an overarching effect on our economic future: the election, the summer drought, the Supreme Court ruling on the Affordable care act, housing market data, QE3, and so on. The direction of the markets do, and should, change with these large level events, but the degree of change is out of proportion with the change in fundamentals. The degree of market change reflects current investor sentiment rather than a balanced accumulation of relevant data. It is as if the markets are acting like a singularly erratic individual who oscillates between nervous dread and cautious optimism. The markets switch back and forth reflecting the latest news, but often overshooting a prudent correction, supported by common sense, into binary votes of overconfidence or panic.
If an investor has a bias, bullish or bearish, it is easy to cherry pick facts to support their point of view. A bearish investor can look at instability in the Middle East, an over-extension of debt by developed nation governments – notably in the Eurozone, and the US government’s insistence on a regularly scheduled fiscal or regulatory crisis and conclude the market has to fall. A bullish investor can look at innovative energy and technology programs, inexpensive long term stock valuations, and a growing global middle class and conclude the market has to rise.
Only time will tell how the market will weigh the dominance of these competing factors.