By: Sarah K. Charles and Bill Laird
What Would Warren Buffet Do?
Once upon a time, the news was published twice a day. In the event of breaking news, publishers might publish an “extra” edition (which is where we get the iconic image of newspaper boys standing on street corners shouting: “Extra! Extra! Read all about it!”) but for the most part you could count on one round of headlines in the morning and another at the end of the day.
My how times have changed. We now live in a 24-7 news cycle and it’s not just that we’re able to read the latest headlines at any time of day on a variety of platforms. We are bombarded with news. Text alerts. Push notifications. Emails. Instead of newsboys standing on street corners we have Tik Tok videos and Instagram stories. These days the news is dished out and served up at such a rapid-fire pace that even if you wanted to, it’s nearly impossible to ignore.
While the primary role of the media is to inform, it can also influence. And if you take the financial media, which has a flair for hyperbole and a tendency to fear-monger, and mix in the constant blitz of our never-ending news cycle, you can see how a deeply personal and important decision – such as how to manage investments or plan for long-term financial sustainability – might be influenced by a simple headline or a news article.
So here are three things to keep in mind the next time you’re reading headlines and thinking about your investments:
1. Beware of The Narrative Fallacy
Below are a few of the daily headlines from last quarter:
“Global markets churn higher on vaccine hopes.” 1
“Stocks mixed as new jobless claims unexpectedly spike.” 2
“Stocks walloped as September selling sets in; tech stocks swoon.” 3
“US futures head higher after FDA increases access to COVID 19 treatment.” 4
Whether the news is good, bad or indifferent, there is a common theme among all of these headlines – the story is framed in terms of cause and effect. Markets did A in response to B. Or markets did X because of Y. Unfortunately, the cause and effect narrative isn’t always accurate – and in fact, it can be misleading.
In 2019 the daily average for world equity trades was $443.3 billion. Think about that. On average, each day, over 443 BILLION dollars traded hands between buyers and sellers across the globe. That’s a lot of activity driven by a lot of participants. And yet, the financial media often overlooks all of the participants placing billions of dollars in trades daily and reduces the story to a single driving factor. Take the first headline: “Global markets churn higher on vaccine hopes.” What’s implied is that across the globe, our collective optimism around a COVID-19 vaccine meant on that day investors were willing to buy shares of publicly traded companies at a higher price than the day before. And maybe that was the case for some investors. But there were likely a number of investors who were motivated by different reasons. Given the sheer volume and wide variety of daily market participants (long-term investors, day traders, asset managers, institutional investors, etc.) it’s impossible to say that a single piece of news or a single factor drove them all to make the same decision, or that any one decision moved markets.
So why does the financial media take this cause and effect approach to reporting? According to Nassim Nicholas Taleb, it’s called the narrative fallacy, and as he explains in his book, The Black Swan:
“The narrative fallacy addresses our limited ability to look at sequences of facts without weaving an explanation into them, or, equivalently, forcing a logical link, an arrow of relationship upon them. Explanations bind facts together. They make them all the more easily remembered; they help them make more sense.”
As we wrote last month, human beings have a need for things to make sense. Combine that with our love of stories and you can see why the financial media takes a storyteller approach to reporting – whether it’s accurate or not. I suspect this is one reason why so many investors have been baffled by market activity these last few months. If the news is bad, why are markets going up? We are so used to a cause and effect narrative that when the cause and effect don’t actually align, we immediately seek explanations to help it make sense.
2. Remember That There are Two Sides to Every Story
Back in March, when markets were dropping at a dizzying rate, we were assailed with daily headlines about a massive selloff as fears of a global pandemic and the possibility of near total economic shutdown took root. But while there were dozens of headlines and articles about the selloff, I don’t recall any stories about who was buying that selloff – and trades don’t happen in a vacuum. For every person selling, there’s a buyer. And for every person buying, there’s a seller.
Imagine if you would have read the following headline: “While fear drove many investors to flee equity markets, there were other investors who saw the higher expected value of stocks over time and stepped in to buy those stocks at a deeply discounted rate.” Would you have felt differently about what was going on in the market? Would you have seen the opportunity instead of feeling fear?
Warren Buffet once said: “Every decade or so, dark clouds will fill the economic skies and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons.”
The challenge for investors is there is a lot of reporting on the dark clouds – with little focus on the gold raining down.
3. Ask Yourself: What Would Warren Buffet Do?
Occasionally someone will mention that they have not checked their portfolio recently. They say it almost apologetically, as if they are not doing a good job of being an investor because they aren’t keeping up with the day to day. But investing is about the long term – not the day-to-day – and I can’t think of a better example than Warren Buffet.
In his book The Psychology of Money, author Morgan Housel offers some insights into Warren Buffet’s success and it’s pretty simple.
“As I write this Warren Buffett’s net worth is $84.5 billion. Of that, $84.2 billion was accumulated after his 50th birthday. $81.5 billion came after he qualified for Social Security, in his mid-60s.
Warren Buffett is a phenomenal investor. But you miss a key point if you attach all of his success to investing acumen. The real key to his success is that he’s been a phenomenal investor for three quarters of a century. Had he started investing in his 30s and retired in his 60s, few people would have ever heard of him…
Effectively all of Warren Buffett’s financial success can be tied to the financial base he built in his pubescent years and the longevity he maintained in his geriatric years. His skill is investing, his secret his time.”
I love that: his skill is investing, his secret his time. And his other secret, in my opinion, is patience. Patience to stay disciplined when headlines are bad. Patience to stay invested through 14 recessions. Patience to let compounding do what it does best – help your money grow. Patience to forgo instant gratification in favor of long-term returns.
There is a giant disconnect between the daily onslaught of financial media headlines, shouting up to the minute market performance, and planning for the future. It’s why one of the most important jobs we have as your advisor is to keep you focused on your long-term goals and dreams. It’s why we take clients through our Strategic Life Planning process: so you have a framework for navigating decisions and a yardstick to measure progress. It’s why we are so passionate about delivering financial clarity and peace of mind.
Between the narrative fallacy, focusing on only one side of the story, and the short-term mindset – the financial media can mislead investors into making poor decisions. So, the next time a headline has you rethinking your plan, ask yourself: What would Warren Buffet do?
Sarah K. Charles, CSRIC™, AIF® - Director
1 Seeking Alpha, 8/21/20 | 2 Yahoo Finance, 8/20/20 | 3 Yahoo Finance, 9/3/20 | 4 Seeking Alpha, 8/24/20 5 Wall Street Journal, 9/30/20 | 6 New York Times, 10/1/20
Despite a pullback in September, both US and Non-US stocks advanced during the quarter posting gains of 8.93% and 5.23% respectively. In fact, it was the best back-to-back quarterly performance for the S&P 500 since 2009. Overseas stocks were assisted by a 3.7% decline in the dollar, continuing a reversal of a long-term trend of dollar strength. Dollar weakness is beneficial for diversified investors who have holdings in international currencies through mutual funds that invest overseas.
During the third quarter, volatility was significantly reduced from very elevated levels in the 1st and 2nd quarters of this year. The S&P 500 experienced only three days where the market fell more than 2%, versus eight days in the second quarter and thirteen in the first. September’s bout of volatility was concentrated heavily in the tech sector as names such as Apple, Facebook and Google pulled back due to valuation concerns after breakneck advances during the year.
As detailed extensively in the financial media, these successful stocks have become a larger and larger part of market indices, making the S&P 500 more top-heavy than it has been in the last 30 years. The advance has also propelled growth index measures well ahead of value benchmarks, particularly in the past three years although it is unclear how long this relative outperformance will sustain. While valuations are elevated relative to historical norms within the tech sector, they are currently less expensive relative to the earnings they provide to the S&P 500 than the highflyers of the late 90s tech bubble, as seen in Exhibit 1.
Source: JP Morgan, Guide to the Markets - U.S. Data are as of September 30, 2020.
While it can be tempting to focus your investments on these fast-growing Mega-Caps dominating both indices and headlines, an investment strategy built around a thesis of concentrating your holdings in a few “invincible” names is fraught with risk.
In some cases, decades of dominance by a company can be followed by a decade or more of decline, erasing most, if not all of the advantage of holding the stock during the previous decades. Investors in General Electric, Citigroup, AT&T or Exxon Mobil can relate to this. The constant change in leadership through the last several decades as represented by the US market’s 10 largest holdings is illustrated in Exhibit 2.
LARGEST 10 US STOCKS AT THE START OF EACH DECADE
Source: Dimensional Fund Advisors
Longer-term metrics outline the reversion to the mean of the US market’s most successful stocks, and the prevalence of the disappearing return advantage for these market leaders after they join The Top 10. As illustrated in Exhibit 3, these names show a disadvantage of 1.5% relative to the market of companies that are new entrants to the top 10 over the next decade. And, as mentioned above, some shareholders of previous highflyers would welcome a return that is ONLY 1.5% behind that of the market.
AVERAGE ANNUALIZED OUTPERFORMANCE OF COMPANIES BEFORE AND AFTER THE FIRST YEAR THEY BECAME ONE OF THE 10 LARGEST IN US
Compare to Fama/French Total US Market Research Index, 1927-2019