Have you ever walked past someone so engrossed in the act of looking up at the sky? The impulse to follow is so strong that sometimes you lose your bearings. It is human nature to follow the herd. That’s because our minds are intuitively framed to take absurd decisions in the direction of the madding crowd. Nowhere is this more evident than in the stock markets. The indiscriminate sell offs through the late fourth quarter of 2015 and into 2016 is a testimony that investors across the board have joined the frenzy.
Since the start of 2016, we have noticed several issues facing the uncertain global economy. Oil and commodity prices collapse, hard landing in China, negative interest rates in Japan, slow growth in US, emerging economies debt juggernaut and further stimulus in Europe are all conjuring up to a bleak global economy. Investors, as irrational beast, are selling off equities and piling up safe havens such as gold and US dollars. Gold has jumped by more than 10% since beginning of the year.
Since the implosion of the financial crisis in 2008, we have been made to believe that monetary stimulus and quantitative easing (QE) by major central banks would have eventually stimulate household consumption, investment and growth. Unfortunately, this was not the case. In the US, for example, financial institutions chose to park their money with the central banks rather than lending to the real economy. Consumers having more as disposable incomes preferred to settle their outstanding debts instead of consuming more. In emerging countries, companies borrowed heavily due to a flood of liquidity available cheaply. This flood of liquidity has excessively gone towards creating assets bubbles, rather than strengthening the real economy. The recent meltdown in equity markets is testimony of such imbalance thus causing investor’s dilemma.
Very often, I meet up with investors who are worried about the uncertainties around. Do you think I should dis-invest from the stock markets or should I wait until the smog of uncertainties clear off? Such questions raise the eyebrows indicating that irrational behaviour has overtaken on rational thinking. Agree that the current uncertain investing environment smells of blood but equity markets always bob up and down like fishing boats off the coast. Haggling with every situation in the equity markets is a sure passport for disaster. Instead, astute investors are never afraid to increase the cash position when markets are high on irrational enthusiasm and equally not afraid to pounce on when markets are down and out.
For legendary investors like Warren Buffet, the investment mantra is very simple. He looked for companies that have an economic moat or competitive advantage. One example of competitive advantage in companies is brand power. A strong brand ensures that there is very little debt on the books and there is a strong cash generation. Another characteristics of brand power is consistency. Wild variations in certain key financial variables as a percentage of gross profit is not a good sign of consistency. Successful long-term investors make money in stocks because they don’t run from uncertainties, they rather embrace this type of opportunities. When investing in stock markets, the focus has to be on the soundness of the business model, the quality of management and more importantly reasonable valuations.
The slump in equity markets was predictable. The frenzy that led to their rise were not accompanied by sound investment principles needed to sustain its momentum. Equity markets is expected to gyrate to the tunes of central banker’s musings and irrational investors in the short to medium term.
Next time you see someone craning his neck towards the sky, make sure you give him a rational advice. To incline his neck towards the sky only in pursuit of bliss for cosmic energies; otherwise you may end up with irrational neck pain.