On Market Volatility

Adapted from an email sent to Investors back in June of 2022

For all investors, market volatility can create challenging times that are financially and emotionally stressful. Still, it’s important to remember that staying patient and disciplined in times of market volatility is one of the core principles of long-term investing. Markets fluctuate on a regular basis in response to a variety of market, economic and geopolitical factors. Being able to distinguish between important changes in long-term trends and short-term reactions in the market can help investors be positioned for future opportunities. 

In The Intelligent Investor, Benjamin Graham, the father of value investing and Warren Buffet’s mentor, wrote a parable about a manic investor, “Mr. Market.” Every day, Mr. Market offers to buy or sell you stock at a price based not on the fundamental value of the asset – but on his mood. In many cases, this mood is determined by what the stock has done in the past day or two, not by a more objective measure of what it is actually worth. It is up to you, as the more rational investor, to be disciplined and diligent in deciding if the price on any given day is attractive. 

There may be days when Mr. Market has underpriced these assets, making it an attractive time to buy and hold. It’s the long-term investor who can decide what to do on any given day. In many cases, they could choose to ignore the price swings proposed by Mr. Market, especially if they have studied market history. This is true no matter how large the fluctuations – or whether we assign them labels such as “correction” or “bear market.” 

Unfortunately, it’s human nature to be drawn to assets with prices that are rising and avoid ones that are falling. This is true even though the past may little impact on what a stock may do next. The irony is that when stocks are the most attractively valued, investors want them the least. Recent price movements should have little bearing on what an asset is truly worth, so learning to overcome this bias takes training, experience, and patience. As you may remember, many investors wish they had been more disciplined after the market began to recover in mid-2020. 

The relevant questions are usually “what is priced in” and “what should be priced in.” Changing interest rates should prompt a re-evaluation of asset prices. This means that the present value of future cash flows is lower or higher, which disproportionately impacts investments with large uncertain payoffs in the distance. In simple terms: it can be hard to know what to pay today to receive $1 in the future because it’s unclear where interest rates will be. As rates rise, it becomes more attractive to simply buy bonds instead. 

Falling bond prices have occurred over several periods in the past 30 years, during periods of rising rates and inflation concerns, only to recover soon thereafter. While the next time may be different, the silver lining is that generating portfolio income is easier today than at any time over the past decade. 

The bottom line? 

As markets find a stable level and the inflation story evolves, it’s important for long-term investors to maintain perspective. Market corrections and even bear markets are normal. Not only do markets historically recover, but that can also happen when investors least expect it. The best course of action is to stay patient, think long-term, and avoid being unduly influenced by Mr. Market.