“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
― Benjamin Graham
My translation is that in the short run, the market measures popularity but in the long run the market measure financial success. Mr. Graham is widely considered the father of modern value investing. Warren Buffet gives Graham credit for establishing Buffet’s disciplined framework for valuing companies while he was Graham’s student at Columbia University in NY in the 1950s. Graham learned his lessons the hard way when he lost nearly everything in the stock market crash of 1929.
His lessons learned from the crash led him to search for an investment strategy that profits from stocks while reducing downside risk. He published his findings in “Security Analysis” (1934), which is now widely considered the bible of investment analysis. He coined the phrase Mr. Market to explain how the markets value stocks. A sharp eyed financial analyst with ice water in their veins may be good at valuing companies, but most people are full of psychological and experiential biases. They are unknowingly driven by many emotions, especially fear and greed. Mr. Market is the same way. The goal of Graham’s strategy was to recognize and discount those market biases and thereby profit and reduce risk. His strategy works great over a full market cycle but at times like these (short term) Mr. Graham’s approach is lagging. At the moment, Mr. Market seems driven more by popularity than the intrinsic value of individual companies. Today’s popularity bias of Mr. Market is partially being driven by a recent trend that has taken off following the downturn of 2008 – 2009. This trend is the proliferation and domination of markets by ETFs and indexing. This proliferation is a good thing for choice and lower cost, but it has not been tested in a down market and by its structure it enhances the upward momentum of the current winners. That might be turned on its head in a downturn where downward momentum is enhanced. Below is a chart of the top 5 holdings of the S&P 500 representing 13.78% of the total index as of market close January 31, 2018.
|3||Alphabet Inc. Class A & C||GOOG||2.92%|
|5||Facebook Inc. Class A||FB||1.85%|
They are all technology companies, they are all wildly profitable and they are all in multiple index funds, ETFs, mutual funds and individual accounts. Apple is the largest holding and probably the biggest risk since the majority of its revenue and its profit come from a single product – the iPhone. I am not a security analysis expert, but from my knowledge I would expect that Benjamin Graham would not buy any of those stocks at today’s prices.
What does this mean for us? We have chosen a relatively conservative strategy in that we have chosen to stay mostly away from indexing and ETFs as a risk control measure. Our investments are doing well and our clients are enjoying the upswing in the markets. We are staying diversified and doing what we can to reduce risk while continuing to participate in the upside. We remain optimistic about the long-term prospects for the continued success of the great companies of the US and the World and consequently we continue to allocate a significant portion of our investments to stocks as the source of most of our return.
Westfield Financial Planning is a registered investment adviser. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and, unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.