John Maynard Keynes once compared investing to picking the winner of a beauty contest. Keynes argued that to win the contest one must choose the contestant he believes is the most attractive in the opinion of others, not necessarily the contestant that is most attractive to him.
Ben Graham, the father of Value investing, once said that in the short-term the stock market is a voting machine, but in the long-run it is a weighing machine.
Keynes and Graham are both right.
For traders and speculators Keynes offers the most relevant advice. In the short-run, the fundamentals matter little. Picking the stocks that your peers find most attractive tends to be the most successful short-term strategy.
For investors, Mr. Graham’s advice is most appropriate. In the long-run, the fundamentals are what determine the value of a firm.
And therein lies the difficulty that so many face in the stock market. The short and long-term focused participants in the stock market are operating at cross purposes. Add in the daily blitzkrieg of opinions and commentary from the financial press that attempt to make sense of it all and you have an investing public that is utterly confused and distracted.
Fear and greed further cloud investors’ judgement, and make what is already an unintuitive task all the more difficult.
Take for example the YTD performance of the 10 sectors in the S&P 500. If I told you on January 1st of this year that the earnings for the energy sector and the utilities sectors were going to be down 33% and 4% in the first quarter, would you have told me that those two sectors would be up 8.3% and 13% YTD? Many investors would have expected energy and utilities stocks to be down.
Negative short-term sentiment drove the shares of these firms to levels that was apparently beneath their long-term values and when sentiment shifted they moved up despite their still uninspiring short-term outlooks.
Unintuitive and contrary to be sure, but to achieve long-term investment success, it is best to do what Graham advised and approach the markets like they are weighing machine. Often this means ignoring short-term performance and sentiment and buying the unloved, the forlorn, and the out-of-favor.
Jeremy Jones, CFA
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