Mr. Market’s Hangover
Mr. Market woke up to 2016 with a massive hangover. As I write this, the market is down over 2% for the day and down around 6% for the year in 2016. He went out partying with his buddy Mr. China in 2015, and they had way too much to drink. Now he has to pay the piper. A little suffering might be in order this year. Last year he was a happy-go-lucky guy, offering well above a P/E of 20 for a share of our business. This year, the hangover has him in a foul mood.
The Parable of Mr. Market
What’s that? You’ve never heard of Mr. Market? You don’t understand what Mr. Tako is talking about? It’s time for you to learn about Ben Graham and the parable of Mr. Market.
Ben Graham is often called the father of value investing. He was the mentor of the greatest investor of our time, Warren Buffett. He wrote several famous investing books in his lifetime. “The Intelligent Investor”, published in 1949, included the Parable of Mr. Market. Everything in that book still holds true today, especially that parable.
If you are intelligent, and a investor, then YOU need to read this book. I own the 4th Edition in hardback. Currently, Amazon sells the Revised Edition with Commentary by Jason Zweig. It’s also on my book recommendations page.
Since it’s legal for me to quote an excerpt from the book, I’ll shall provide you with the parable in Ben Graham’s words. From Chapter 8, page 108 (my edition):
“Let us close this section with something in the nature of a parable. Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometime his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposed seems to you a little short of silly.
If you are a prudent investor or a sensible businessman, will you let Mr. Market’s daily communication determine your view of the value of a $1,000 interest in the enterprise? Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price and equally happy to buy from him when his price is low. But the rest of the time you will be wise to form your own ideas of the value of your holdings, based on full reports from the company about is operations and financial position.”
and Ben Graham goes on to say this on page 109:
“Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell widely when they advance a great deal. At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”
Reasons I’m Not Worrying
A recession could very well be upon us in 2016. As an early retiree, I could be worried, but I choose not to be. The price of my assets will fluctuate up and down all the time. I have several reasons to be optimistic.
- The market is not at ‘bargain’ valuations yet. Mr. Market is moody and frequently irrational. We will pay attention to the business returns of our companies and the dividends they pay. So far everything looks fine there.
- Corrections and declines are a normal part of the economic cycle. Boom and Bust. Busts are a good time to buy, but we’re only in correction territory right now.
- Most of my income comes in the form of dividends, not from sales of stock. This means I don’t have to sell when prices are down. Instead, I’m going to be buying with my excess cash.
- Lower prices means higher returns when I invest. I like higher returns!
Reasons to be Patient
Should you jump in and start investing already? The year has only just begun. Mr. Market has only just woken up from his 2015 binge and the ‘new reality’ is just settling in. Here are the reasons I’m going to be patient with my investing dollars:
- The S&P 500 PE ratio sits at 19.81. That’s well above the median of 14.61. The market is still over-valued by historical comparisons.
- The price of oil isn’t headed up. Since I wrote about the oil and gas industry in December, the price of oil has continue to decline, as I thought it might. However, the price isn’t down to cash costs yet, so it’s unlikely we’ll see production declines (yet). Basically, I think oil prices could go even lower still.
- China’s construction and industrial slowdown is causing significant ripples in the price of commodities. In some industries this may cause price deflation. For some companies this may end up being a “good thing”, or a “bad thing”. It depends upon who has pricing power.
- Rail Traffic is down slightly. Typically rail traffic is a leading economic indicator. This could mean a recession is on the way. Recessions usually mean lower stock prices.
Looking Forward
No matter how I twist the facts, I think we could be in for more of the ‘same tune’ that’s been playing in this first month of 2016. There are very few scenarios where I see 2016 being a very positive year. Lower commodity prices may work their way through the economy and cause something of a recession. Some companies may have pricing power, and will be able to resist the price declines. If Mr. Market stays in his foul mood (as I suspect he might), there could be some great investment opportunities ahead!
What do you think? Should I be worried and horde cash? Should I start investing now?
Featured Image Credit: Wikimedia.
Hello Mr. Tako,
we have a gut feeling there will be more hangovers for Mr. Market in 2016. We have been very slow with investing so far, there is a good change more bargains are on the way in the coming weeks and months. But you never know!
Cheers.
I think your gut feeling is right. The data seems to indicate some kind of decline. Lower energy and commodity prices will work their way through the economy. Lower revenues are usually not good for stock prices. From what I’ve read, the lower prices have not benefited the consumer enough to compensate for losses in the energy industry (yet).
Quick question, you mentioned in your about page your net worth is $2M with your wife, and you have a $2M stock portfolio. Does that mean 100% of your net worth is in the stock market after retirement?
If so, where did you develop your balls of steel?! 🙂 Only about 30% of my net worth is in the stock market, as I’m not a big fan of public equities having worked in the equities business my entire working career.
What is your net worth composition?
Sam
Off the top of my head – About 25% in cash, 35% stocks/index funds, 20% Real-estate or REITs, and the remaining 20% is in bonds/preferred shares. That’s for right now. Yes, 25% cash is correct. Not a typo. Burning a hole in my pocket, but with the market down this year, not so bad afterall. 😉
Cool. No desire to own real estate or other hard assets?
I noticed in your about page you said you made money “the hard way,” and not through working in finance or selling stock options in tech. Can you explain why you think your way is harder than the other way?
I do think it is impressive to make less than $100,000 a year and get to $2M in net worth by 38, given that is $100,000 X 16 = $1.6M in gross income, and ~$1.1 M in net income if you made $100K and saved 100% of it. Do you have a more detailed post on your journey to $2M? I think that would be a fascinating read!
What is your wife’s net worth? Or is the $2M altogether? If altogether, what percentage do you think she contributed?
Cheers,
Sam
That’s a lot of questions Sam. I won’t try to answer them all here. We’ll document some of it in the blog in the future, I’m sure…keep reading. 🙂
By using the common expression “the hard way”, I intended to indicate we had no financial windfalls, nor high salaries. Just carefully controlling the budget and saving about 50%. So yes, I do think windfalls (like stock options) and high salaries make saving a number like that easier. If you make $500k/year or suddenly come into $1.5M from winning the lottery, then $2M isn’t much at all.
Cool. Looking forward to it! I think your post will be a hit showing how you got to $2M w/ under a $100K salary since college, especially since there’s been a couple downturns since.
The one thing to note is that those making $500K/year for the same period are probably around $5M – $10M in investable assets or net worth for the majority. It’s just that nobody really knows b/c of Stealth Wealth! 🙂
I am hoarding cash and continuing to purchase Total US Stock Index. Both my wife and I max out pre-tax retirement contributions, and that goes into VTSAX. Instead of also putting after tax $s into the market, we are hoarding a stash for the moment. Our 3-year plan is to pay off the mortgage if no better opportunity comes along. I am happy with this plan right now as mortgage-free is what financial freedom looks like to my wife. Thus a plan to pay off the mortgage in a short time frame has been highly motivating to her.
But I do not kid myself that I have a clue what the market will do – I am not an intelligent investor like you Mr Tako. I just do dollar-cost averaging and try to make the greatest profit by keeping household costs low and savings high. Thanks for the article. -Ap.
Keeping costs low and savings high is 90% of the work. In this ‘slow GDP growth’ environment it’s unrealistic to assume there will be large advances in the stock market. I’m in agreement with the smart folks that predict lower returns than ‘historical averages’. Certain segments might outperform, but most people just invest in the whole market.