Ask anyone why they invest in the stock market and you'll get the same answer: to make money. Yet considering the behavior of many market participants, you would think people were trying to lose money.
Instead of buying low and selling high, most "investors" buy high and sell low. Even worse, many of them have no idea they are doing it because they are buying high and selling higher.
Yesterday morning, news headlines were consumed with the Federal Reserve's emergency cut of 75 basis points. The market was expecting a cut of 50 when the Fed was scheduled to meet Jan. 30. But investors, coming off a long weekend that included severe declines across nearly all the global markets, were naturally surprised. Their pent-up anxiety led to an opening-bell decline of a magnitude not seen since September 2001.
What's different this time?
There can be no doubt that the severe decline in available liquidity that companies like Citigroup (NYSE: C ) , Merrill Lynch (NYSE: MER ) , and Countrywide (NYSE: CFC ) have experienced is hampering the market. Warren Buffett's comments a couple of years ago, that "derivatives are financial weapons of mass destruction," now seem prophetic.
Simply put, the U.S. economy via the consumer assumed a tremendous level of leverage over the past couple of years. The deleveraging now taking place is akin to airing the dirty laundry. There's still loads of the stuff that needs to be cleaned up.
So if you were buying stocks like Countrywide or MBIA (NYSE: MBI ) a few months ago because the price was so low, you now realize your were buying high. There is a significant difference between a low-priced stock and a cheaply priced stock. The 400-point-plus initial decline in the Dow Jones index offered long-term investors an opportunity to add to existing positions or establish new ones.
"Short-term investor" is an oxymoron
Short-term investors out to make a quick buck will suffer in this environment. No matter how global today's markets are, when the country that accounts for roughly 25% of global output endures setbacks, everyone will be affected. We're already hearing news about Chinese banks taking asset writedowns as a result of U.S. subprime exposure.
Capitalism will always go through times of excessive speculation that are followed by a cleansing period, and these times will differ in severity and duration. What is certain is that investors who participate in equities with a businesslike mindset and establish a multiyear horizon will benefit tremendously from these corrective phases.
Follow the leaders
Rather than let daily market quotations, which are meaningless in the short term, dictate your approach, why not go back and examine activities of great investors? Here's a helpful quote from the partners of Tweedy Browne:
One of the many unique and advantageous aspects of value investing is that the larger the discount from intrinsic value, the greater the margin of safety and the greater potential return when the stock price moves back to intrinsic value. Contrary to the view of modern portfolio theorists that increased returns can only be achieved by taking greater levels of risk, value investing is predicated on the notion that increased returns are associated with a greater margin of safety, i.e. lower risk.
Follow this course and you will profit tremendously in this pessimistic market environment.