At the time of writing, the MSCI World Index is up around 21% from its March low. This performance has stunned analysts and investors around the world. It seems to me this is one of the most hated stock market rallies of all time.
It is easy to see why analysts are skeptical. The global economy is reeling from the coronavirus crisis. While governments are doing everything they can to help businesses survive, surging levels of unemployment, rising corporate failures, and collapsing consumer confidence all suggest that the economy is heading for a sharp downturn.
These conflicting signals present a challenge for investors. On the one hand, market actions suggest the crisis will be short-lived, with a minimal impact on businesses. This is a buy signal.
On the other hand, emerging economic data implies the global economy is heading for one of the worst downturns in history. That suggests selling the rally might be the right course of action.
Having said all of the above, research shows that trying to fight or time the market is generally a waste of time. We don’t know what’s going to happen next, so there’s no point trying to predict it.
Instead, the best course of action for investors could be to ignore the market and focus on finding value.
Howard Marks advocated just that in his most recent memo to clients of Oaktree Capital on April 6:
“The old saying goes, “The perfect is the enemy of the good.” Likewise, waiting for the bottom can keep investors from making good purchases. The investor’s goal should be to make a large number of good buys, not just a few perfect ones. Think about your normal behavior. Before every purchase, do you insist on being sure the thing in question will never be available lower? That is, that you’re buying at the bottom? I doubt it. You probably buy because you think you’re getting a good asset at an attractive price. Isn’t that enough? And I trust you sell because you think the selling price is adequate or more, not because you’re convinced the price can never go higher. To insist on buying only at bottoms and selling only at tops would be paralyzing.
So it’s my view that waiting for the bottom is folly. What, then, should be the investor’s criteria? The answer’s simple: if something’s cheap – based on the relationship between price and intrinsic value – you should buy, and if it cheapens further, you should buy more.”
Marks isn’t the only seasoned investor that holds this view.
In his 2008 letter to investors of Baupost, Seth Klarman explained the folly of waiting for the market bottom:
“Baupost built numerous new positions as the markets fell in 2008. While it is always tempting to try to time the market and wait for the bottom to be reached (as if it would be obvious when it arrived), such a strategy has proven over the years to be deeply flawed. Historically, little volume transacts at the bottom or on the way back up, and competition from other buyers will be much greater when the markets settle down, and the economy begins to recover. Moreover, the price recovery from a bottom can be very swift. Therefore, an investor should put money to work amidst the throes of a bear market, appreciating that things will likely get worse before they get better.”
Both of these seasoned investors appear to believe that timing the market is a waste of time and effort.
Instead, it seems they both believe that investors would be better off using their valuable time to find undervalued securities.
As long as you invest when the business is worth less than its intrinsic value, it does not matter what the market does over the next few weeks or months. In the long term, price should align with value.
But in the current market, it’s difficult to value corporations. Here we can learn from Benjamin Graham’s advice from his first book, Security Analysis.
In Security Analysis he and David Dodd discussed the concept of a range of value:
“The essential point is that security analysis does not seek to determine exactly what is the intrinsic value of a given security. It needs only to establish that the value is adequate— e.g., to protect a bond or to justify a stock purchase—or else that the value is considerably higher or considerably lower than the market price. For such purposes, an indefinite and approximate measure of the intrinsic value may be sufficient.”
To be a value investor, you must buy at a discount from underlying value. Analyzing each potential value investment opportunity, therefore, begins with an assessment of business value, not market sentiment.
In times of crisis, buying at a discount becomes even more critical than ever.