I want to let you in on a small Wall Street secret: No one knows what the stock market will do next. Don’t be fooled by their fancy pedigrees, the gazillions of dollars they manage, the eloquence of their logic, the myriad of data points they marshall. Nobody but nobody knows what the stock market will do tomorrow, next week or next year. Stock market behavior in the short term is completely random. Completely! You’ll have better luck predicting the next card at a black jack table than guessing what the stock market will do next.
The media of course needs to fill pages and rack up views, and so there are multitudes of explanations for why the stock market does this or that. The explanations always sound rational, but for the most part they are worthless because they have zero forecasting power. A strong jobs report sent stocks up. Explanation: The economy is doing great. A strong jobs report sent stocks down. Explanation: Investors are worried about higher interest rates. I can give dual spin to any news, maybe only short of nuclear war.
My biggest problem with “The stock market will do this” headlines is that they turn investors into degenerate gamblers. I see people trying to treat the stock market like a casino. They get lucky at times and catch the wave of randomness (especially if the market marches higher every single day). Success goes to their heads, they feel like they’ve got this whole stock market thing figured out. Stocks are just bits of data that are priced on the exchanges gazillions of times a day. This is not investing – I don’t even want to insult gambling by calling it gambling. At least gamblers don’t gamble with their life savings and 401k’s (unless they are degenerate gamblers).
What will the stock market do next?
It’s the wrong question. It’s the question that should never be asked, and if asked should never be answered. Asking this question shows that you believe there is some kind of order to this random madness. There is not. And if you answer with any answer other than “I don’t know,” you’re a liar.
How do you deal with market declines? Stop looking at the market as if it were a casino and start treating stocks as businesses that you are trying to buy at a discount to fair value. Stock price is an opinion of what the market is willing to pay for this business right now. Yes, it’s an opinion, not a final judgement. The stock market is going to be a miserable place for you in the long run if you take market opinions on any given day seriously and treat them as final judgements.
If you start treating stocks as businesses and you start analyzing them and valuing them as such, then market drops stop being a source of pain and turn into a source of pleasure. I read somewhere that most money is made during bear markets (when you buy stocks on the cheap) – it just doesn’t feel that way at the time. Even if you are fully invested, why does it really matter that the market decided to price your stocks lower today (unless you believe the market is right)? Will it matter in three, five years from now? If you own undervalued companies, they may get more undervalued before they become fully valued. As long as you’ve got the valuation right, you’ll eventually be proven right.
Let me tell you what we did when the market took a dive. We looked at stocks we owned and asked ourselves a question: Had their values changed? They had not. Then we asked if we wanted to increase our positions in any of them. Then we looked through our long watch list to see if any stocks had hit our buy-price targets. That was it. That is the only rational way to invest. Anything else is …