Market Trivia & Investing vs Speculating

11 January 2016 | by Sean Stannard-Stockton, CFA

2016 has started off with the first week showing a sharp decline in the stock market. So sharp in fact, that media outlets everywhere are noting that the 5.9% decline in the S&P 500 represents the worst first week of the year since 1928!

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Many media reports have offered this piece of trivia while clearly implying that it suggests a rough market in the year ahead. Bespoke Investments (whose chart is shown above) on the other hand is quoted in this weekend’s New York Times saying that when it comes to predicting how the market will perform for the rest of 2016, that they “have no idea”.

The fact is that market performance during the first week of January holds no special power over how the rest of the year plays out and the media coverage of the sizeable decline is trivia masquerading as insight. Bespoke’s table shows that the most difficult first weeks of January have been followed by terrible years such as 2008 when it declined a further 35%, but also by fantastic years like 1991 when the market rallied another 32% and unremarkable years such as 1978 and 1969 when the market finished the year within 10% of where it ended the first week of January.

When it comes to investing, it is critical to distinguish between actionable insight and meaningless trivia. One of the most constructive ways to do this is to pay special attention to new information about company fundamentals while generally ignoring new information about financial market gyrations. The obsession so many investors and so much of the financial media have with market information relative to fundamental company information exposes the fact that they are in fact speculators and not truly investors.

Here’s my friend and smart equity analyst Todd Wenning quoting the legendary Ben Graham on the distinction between speculating and investing:

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So what does this mean for how investors should react to the recent selloff? First of all, let’s be clear that just because the recent decline is not evidence of a pending deeper selloff, that does not mean that we’re going to see a market bounce. Bespoke’s data shows that further and even deep selloffs have occurred after difficult first weeks. Instead, investors should pay heed to Ben Graham’s advice and review their portfolio to see if the recent market fluctuations offer them the opportunity to reposition in ways that might enhance their expected future performance.

While market fluctuations are a source of opportunity for investors, they often happen in reaction to important, new fundamental data. The selloff in the Chinese financial markets may indeed crimp the amount that wealthier Chinese consumers spend. The decline in oil may lead to energy producers cutting costs further and laying off more people or even going bankrupt and triggering losses at banks. While the US employment report on Friday showed robust job creation and may signal stronger spending by US consumers and a better economy in the year ahead.

Given the firehose of information that investors have access to today, it is critical to learn what to focus on and what to ignore. The best investors design strong mental filters so they can spend their energy considering how relevant actionable information should fit into their outlook while not wasting their time on irrelevant trivia, such as the market returns from the first week of January.

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