“Don’t do something; just stand there.” – Jack Bogle
One of the phrases you’ll hear over and over again once stocks start to fall is ‘headline risk.’
I’ve already hear it a number of times this week.
Most investors like to think about stock moves and risk in a cause and effect context. It makes us feel better when we can attach a narrative to the daily movements of the markets.
Unfortunately, because of the fact that markets are ultimately controlled by the behavioral psychology of a large group of participants with different goals, emotions and time horizons it’s not always easy to summarize exactly why stocks go up or down.
Most of the time the headlines are a good excuse to make trades one way or another, even if the news isn’t the root cause of the market gyrations.
Researchers in the late 1980s looked at the fifty largest one day stock market gains and losses from 1941 to 1987. They studied the political, macroeconomic and world events that were cited by the press as the reason for stock price movements to determine if there was any causal relationship.
Here’s what they found:
On the most sizable return days, however, the information that the press cites as the cause of the market move is not particularly important. Press reports on adjacent days also fail to reveal any convincing accounts of why future profits or discount rates might have changed. Our inability to identify the fundamental shocks that accounted for these significant market moves is difficult to reconcile with the view that such shocks account for most of the variation in stock returns.
Our results suggest the difficulty of explaining as much as half the variance in stock prices on the basis of publicly available news bearing on fundamental values.
So basically the headlines that we read about every day trying to explain why stocks move up or down don’t really have as much of an impact as we all assume.
At times like these, when we have large daily gains and losses in the markets, long-term investors tend to try to turn themselves into day traders.
Do not try to become a short-term trader just because there is some turmoil in the markets.
If you haven’t been a short-term trader in the past, volatile markets are not the time to try your luck at predicting daily market fluctuations.
I looked into the fifty largest daily moves listed in the study and found that a large majority of those gains and losses were clustered around one another.
For example, 66% of the fifty largest moves took place over just four periods of time — 1946, 1974-75, 1982 and 1987.
Yet there was really no discernable pattern of gains and losses in those periods. Large gains and losses happened with nearly the same frequency. Up one day down the next.
Roughly 45% of the biggest daily moves were losses while 55% of the time they were gains ranging from the largest loss of -20.47% to the largest gain of 9.10%.
The same dynamic played out in 2008 when we saw huge daily gains and losses on a weekly basis (although the moves this year are nothing in comparison to the financial crisis).
Trying to time these big changes can leave you whipsawed if you try to play the guessing game of which one will come next.
I realize that the losses we’ve seen since the start of the year are’t exactly a good time. No one likes to lose money.
The S&P 500 was down around 3.5% in January and it’s down again in February.
Just know that this is not an uncommon occurrence, especially after the strong gains of the past five years.
From 1956 to 2013, the S&P 500 has had negative monthly performance over 37% of the time. And 16% of the time it finished with losses of greater than 3% while almost 10% of all months finished with losses in excess of 5%.
Even with those losses you still would have doubled your money every 7 years or so over the long haul.
I have no idea if the pain will continue or if this is just another minor blip on the journey to further record-setting highs.
I do know that it’s a losing strategy to become a day trader on the fly without understanding the fact that playing the short-term is a game best left to the professionals.
Your biggest advantage over the pros is the fact that you don’t have to worry about shorter time horizons.
You have the ability to implement a long-term investment plan without worrying about the day-to-day moves in the market or figuring out why it is that they occur.
What Moves Stock Prices? (NBER)
No for my best reads of the past week:
- How embracing his ADD made this blogger a better investor (Your Wealth Effect)
- John Bogle channels Benjamin Franklin to explain the power of compounding (CNBC)
- 5 tips for younger investor who are just starting out (Financial Post)
- Jason Zweig’s “magic” number for retirement (Reformed Broker)
- Dilbert explains behavioral economics (Psychology Today)
- Barry Ritholtz sets the stage for the long-term by looking at past cycles from the 1942 & 1974 lows in comparison with 2009 (Big Picture)
- Investors leave 80% on the table (MarketWatch)
- Cullen Roche on how hard it is to find the proverbial “fat pitch” (Prag Cap)
- 10 Characteristics of debt free people (MarketWatch)
- Taking money off the table to diversify emotionally (Abnormal Returns)
- Emerging markets: Boom, bust, repeat, yawn (Rick Ferri)
- Video: Jerry Seinfeld & Howard Stern (Comedians in Cars Getting Coffee)
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