Seven Lessons from Mr. Market in 2020

Seven Lessons from Mr. Market in 2020

In Ben Graham’s The Intelligent Investor, he introduces Mr. Market, which is an allegory that is meant to help the reader understand the irrational, groupthink and herding mentality that can take place in the stock market. Joel Greenblatt, former hedge fund manager and popular value investor and author described Graham’s Mr. Market concept like this: “One of the greatest stock market writers and thinkers, Benjamin Graham, put it this way. Imagine that you are partners in the ownership of a business with a crazy guy named Mr. Market. Mr. Market is subject to wild mood swings.”

This year’s market certainly had its fair share of mood swings, but it’s times like this that offer up important lessons for investors. Here are seven points investors should consider as they think about Mr. Market temper tantrums and how to handle the misbehavior in the future.

[1] Staying Optimistic and Focusing on the Long-Term

On March 18th, 2020 I wrote an article, “Learning from Buffett and Others During Market Crises”. At the time, the market had witnessed a 30%+ decline, the fastest in history, COVID-19 was spreading throughout the world, global economies were shutting down, industries were getting demolished and one could see how we potentially were on the brink of collapse. But in the article, I relied on the wisdom from great investors and individuals – Warren Buffett, Peter Lynch and Winston Churchill – to express a view that over time the market would go on to recover and that taking a long-term view was what most investors should focus on. Of course, I didn’t know that the S&P 500 would bottom on March 23rd, at 2337 and we’d be hovering around 3650 today (a 56% move higher), but what I strongly believed at the time was that stocks wouldn’t go down forever and that at some point they’d go on to recover. The timing of my article was lucky, but the message was spot on.

[2] Importance in Asset Allocation

This year is a good example on the importance of asset allocation. A simple portfolio of 25% each in stocks, short term bonds, long term bonds and gold, also known as the Permanent Portfolio strategy, is up over 15% this year, or about double its performance since we started tracking the strategy in 2006. Even the 60/40 stock and bond portfolio is up over 12% for the year. These portfolios didn’t see anywhere near the decline of an all-stock portfolio in February-March, and yet they have both produced respectable double-digit gains, while allowing investors to sleep well at night. They say diversification is the only free lunch in investing and it’s often underrated, but this year is a good example of the importance of being diversified, particularly for investors living off their investments that may have a shorter time horizon.

[3] The Upside and Downside of Stock Picking

In my opinion there is a lot of speculation and froth in certain parts of the market today – IPOs, SPACs, investors driving up the stocks of bankrupt companies – and the number of accounts at online brokerage firms like Robinhood and E*Trade have exploded this year. Some of that is the bad news. The good news, however, is that millions of investors are getting exposed to investing and buying individual stocks. In episode #40 of our Excess Returns podcast, we discussed what Peter Lynch may say to some of these newbie investor (Six Lessons New Robinhood Traders Could Learn From Peter Lynch). Some of these younger investors will graduate and form good stock picking strategies and skills; some will get smoked and learn the hard way that they are taking too much risk or investing based on pure speculation. But I’m not in the camp that individual investors shouldn’t buy individual stocks – some of the most successful individual investors I know personally buy and sell individual stocks. Oh, and by the way, this year retail investors are beating the pros

[4] The Risk of Market Timing

With timing the market, there are always two decisions – when to get out and when to get in – and this year couldn’t have been a better example of the risk of market timing. Investors who moved out of the market earlier in the year (and many did) on fears of further declines would have had to quickly get back in or they would have left a lot of money on the table. Some investors may have been right on getting out before some of the large declines, but I seriously doubt those investors moved back in. The S&P 500 is now up 14% for the year, any timing decision to get out of the market earlier in year, especially given how quickly stocks rebounded, would have resulted in detraction from returns and those investors who still aren’t in may have seriously damaged the long-term returns of their portfolios.  

[5] Seeing the Value of Value in Real-Time

I am personally invested across a number of the quantitative models we offer investors through our capital management firm. So in my accounts, I have growth and value strategies represented. As we like to say, “we eat our own cooking”. While on a full year basis, the growth and momentum models are beating the value approaches, it’s been amazing to see the reversion back in some of our value models, particularly the strategies that have the biggest value multiplier effect (or those that have performed best historically when value has been outperforming). It confirms a few things for me when it comes to value investing, which is backed up by more than my personal anecdotes. The first is if you are going to invest in a basket of statistically cheap companies, be prepared for droughts of lackluster returns, very bad returns coming into most economic contractions and then explosive moves higher as you come out of those recessions. The value effect seems to be accentuated in small caps, which also tend to be riskier. It may not always work this way, and there are many reasons why value investing may be less profitable than in the past, something we’ve talked with many guests of our podcast about, but the reversion in some of our value models has been nothing short of amazing.

[6] Separating Investing from Your Politics

In 2016 when President Trump won the election the S&P 500 went up 5% from early November through the end of the year and continued to rally into 2017 on lower taxes, less regulation and the idea that a “business-minded” president would be good for business. The democrats who thought Trump would be bad for stocks were wrong. Since November 3rd of this year, the S&P 500 is up over 10% on the idea President- Elect Biden will support deficit spending, more stimulus and a divided government is generally favored by investors. Those Republicans who thought Biden would be bad for the market or that stocks would fall as larger government mandate are more likely have also been wrong. The point, as my partner Jack Forehand wrote recently in his piece, “The Importance of Separating Your Politics From Your Portfolio”, is that your political views should not impact your investment strategy.

[7] Staying Disciplined, Rational and Humble

In our interview earlier this year with Professor Lawrence Cunningham, we asked him how he would boil down Buffett’s success. He said, if pressed, he would highlight Buffett’s disciplined rationality as one of those key attributes. Maintaining discipline and staying rational in the face of large market declines and massive market advances are two very important qualities. I would also add in humility as a third ingredient to long term success in the markets, because overconfidence can lead to increased risk taking, which ultimately could lead to bad decisions.

What the future holds for stocks in 2021 is anyone’s guess. But the one thing we can say for sure is that Mr. Market will continue to misbehave in the short run, and those times will present learning opportunities. Those investors who take those opportunities are the ones who will be most prepared for the future. 

Justin J. Carbonneau is VP at Validea & Partner at Validea Capital Management.
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