FOOL ON THE HILL
An Investment Opinion
When the Market Bites Back Bill Mann (TMF Otter)
October 15, 1999
Every morning I scan the newswires to see what strikes me as deserving Foolish comment. Today was easier than most, as I watched each of the major indices drop nearly 2% in the first 15 minutes of trading. While The Motley Fool is dedicated to educating the individual investor about the inherent strength of identifying the best companies and sticking with them, clearly such precipitous drops can tie investors' tummies into knots. So, rather than ignore the source of anxiety, let's examine it, shall we?
But first, an affirmation. On days like today, when the carnage of our portfolios is great, it becomes ever more important to remember that "the market" is a collection of all our actions or non-actions. So say it with me now: "I am the market!"
After you've done this, take a quick glance at the companies in your portfolio. Don't look at today's performance -- just scan the list of companies you own. Has anything changed since yesterday for any of them? Are any of them really, really vulnerable to consumer spending changes? If so, why? This short, educated exercise will tell you very quickly whether you have any long-term worries or not.
Feel better? OK. Let's take a look at the major underlying issue precipitating today's drop.
Most important was the rise in the Producer Price Index (PPI) in September by 1.1% over the previous month, the largest monthly gain in nearly a decade. The PPI measures wholesale costs, or the price of goods and services before they get to the end market.
This type of measure is important as the Federal Reserve uses PPI as a key indicator in determining whether it believes the level of inflation is accelerating. To counteract inflationary pressure, the Federal Reserve may raise interest rates to remove some liquidity from the market. Higher interest means more expensive access to money for companies, which is particularly troubling for high-growth, money losing industries such as the Internet.
This is an extremely simplified version of the facts, but that's just the thing, isn't it? The PPI is a sign of something which MAY cause something which WOULD cause something else which WOULD be bad for certain companies, because it would have the effect of slowing growth.
To which I respond: "So?"
Let's look at first at the PPI and its components. By extracting out energy prices, which have admittedly skyrocketed, the rate drops to 0.8%. Remove food, tobacco and automobiles, and it falls to 0.1%. That's right, three components of the index account for almost all of the wholesale inflation.
This is not to discount the severe effect unchecked inflation can have upon our economy. But let's think about this -- energy (a necessity in all industries), food (important to many industries), tobacco (hardly), and automobiles (barely), but beyond these, all the other cost components were more or less flat. And the market is down more than 2% (as measured by the Dow Jones Industrial Average, the S&P 500, and the Nasdaq). This is not logical. It is fear, the same kind of fear that "Mr. Market" needs to survive.
Mark Twain once said "there are two times in a man's life when he should not speculate: when he can't afford it, and when he can." There's a lesson here. In order to maintain a healthy growth rate for the overall economy, the Federal Reserve may see it fit from time to time to raise or lower interest rates. The Fed is not doing this to punish anyone, it is simply doing what it deems necessary to keep the economy growing at a healthy rate. The demonizing by investors of Alan Greenspan that follows each rate hike is just as misplaced as the deification of him when money flows free.
So what should we think when the market panics because of some factor that portends an environment less conducive to rises in security prices? Cash everything in and cycle into bonds? Buy utility stocks? Do nothing?!? Certainly bonds offer more safety during market downtrends, but remember, by doing so you are assuming that you can time the market, and you can do so better than anyone else. Please trust me when I say that the Wise will not hold the bus for you when they decide to take off again.
Let me demonstrate what I mean. Between January 1, 1990 and today, the S&P 500 has gained 357%, or an annual rate of 16.6%. In this time, the markets have been open in excess of 2,200 days. If you were out of the market for the 10 days that the S&P 500 made the most money, do you know how much profit you would have missed?
More than 55%. So by missing 0.4% of the days your annual return would be reduced down to 7.4%. If you miss the top 50 days in terms of gains your return for the decade would be zero. In a decade during which we have seen consistent annual gains, you would have exactly the same as you started with in 1989.
To my mind, every time some babbling head spouts off about investors needing to find safety, or even better, the CNBC mantra of "flight to quality," I imagine another raft of investors being railroaded by bad financial management. Even the poor Joe who managed to miss the best 10 days of the decade in stocks beat all but the highest fixed income portfolios, a fact that seems to be forgotten during the height of these periodic fits of anxiety.
So what would make me anxious? Well, adverse news directly effecting the long-term ability of my companies to make market beating returns, for one. Things like rapidly expanding corporate debt, product inferiority, gross mismanagement, or long periods of recession. But does the movement by the Federal Reserve to keep the economy healthy make me break into a sweat? Not at all.
Once again, the goal of Fools should always be to hold the best companies, and to hold them for as long as they remain so. If a company retains its leading position in a crucial market during an economic downturn, the prudent Fool looks to capitalize on its decrease in price. Economies cycle in and out, and for all of the economic gooroos' protestations to the contrary, no one has figured out a way to accurately determine when the next cycle is coming in.
So the market dropped a bunch today, eh? (Actually, a bit of an admission, in classic Foolish sense I have not checked the market since my morning scan through the news.) These events give us reason to review our portfolio, and if need be weed out the companies we no longer have faith in for the long term. But I don't sweat the fluctuations, because even if Intel (Nasdaq: INTC), Nokia (NYSE: NOK) and Berkshire Hathaway (NYSE: BRK.A) get pasted today, I am certain that they are all going to survive any short-term economic swoon and come through in the long run far ahead of the crowd.
-- Bill Mann, October 15, 1999
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Related Link: Greenspan Speaks About Risk, October 15, 1999