Stock Market Today
Stock market today is filled with fear and investor pessimism. The economic conditions in US, Europe and around the world are not making it easy for investors to continue to invest. And with the federal government running up excessive debt, and the inevitable credit rating downgrade by S&P, the future of the economy is not looking particularly bright. No wonder so many investors are more concerned with preserving what ever capital they have left than being active in the stock market.
On the flip side, savvy investors see the market for what it is – "a once in a lifetime opportunity to purchase quality companies at low prices"
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In the Short Term Markets are Always Volatile
With so much of economic gloom we are subjected to on a daily basis, it is no surprise that we lose sight of the bigger picture. A free market economy is like a heat seeking missile. Its target is to find any and all pockets of value and exploit it for the betterment and prosperity of the society as a whole. All innovation, growth, new technologies and services arise from this relentless pursuit of value. As long as the free enterprise continues to prosper in US and around the world, the market will continue to do its work.
In the short term however, markets are always in flux. They respond to a variety of stimuli, as diverse as the economy, election cycle, hurricanes, security concerns, free trade agreements, M&A activity, the Greek economy, and so on. Old companies die and new businesses are created. These are just day to day adjustments that are being made so the market continues on its overall long term path of growth and value creation.
A long term investor needs to be able to take this volatility in stride and focus on finding investments that will transcend short term economic upheavals.
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How to Find Great Investments and Manage Your Risk
When thinking about risk with stocks, one needs to cast aside the traditional idea or using volatility as a proxy for risk. The kind of risk an investor really needs to worry about is the risk of his investments losing value over time. I like my stocks to be volatile on the upside, regardless of what the pundits have to tell me.
With that in mind, it makes sense to invest in stocks that are already depressed in price and even in the worst case scenario they do not have much more downside left in them. As long as we also make sure that the underlying business is fundamentally sound and has a potential to turn around over time, these can make for excellent long term investments.
Interestingly, when pessimism rules the markets, these kinds of undervalued investments become plentiful, as they are indeed today. However, undervaluation can occur at any time for many different reasons and an investor will always be able to find such stocks provided he is willing to cast a wide net and look in areas that are generally ignored. Over my 15 years of investing in stocks like these, I have found that small cap segment is an excellent source of undervalued stocks due to lack of analyst attention on them. In fact, many studies have shown that small cap value stocks are the best performing asset class over long term. There are also studies that show that small cap value stocks are the best asset class to be invested in when the economy is just coming off a recession.
Exercise Caution and Do Not Ignore the Short Term Conditions Completely
Long term can be strange. We might be dead by the time long term arrives or many new unanticipated events might have occurred that make our investment choices ineffective. It is always important to consider the information on the economy and other factors that may influence the stock price in the short term in our investment decisions. So for example, if we are worried about higher interest rates and high inflation in near future, it is just common sense to stay away from companies that carry significant debt or are highly sensitive to interest rates (such as financials). On the other hand, companies that are rich in tangible assets (real estate, commodities, equipment, etc) tend to do very well in inflationary environment. A wise investor will avoid stocks of the companies in sectors that he anticipates will perform poorly and lean towards stocks in sectors that he anticipates will be favored by the economic conditions.
Value investing works extremely well and it works even better when a little common sense is mixed in.
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