I’ll admit it – I’m a Dilbert junkie. During my career I have worked in large companies which often displayed some of the behaviors Scott Adams skewers in his comics. In addition to his quick wit and perceptive eye, his pointed (and somewhat twisted) humor keeps me coming back for more.
Whenever I hear “_______ is the key to _______” I immediately think of the above comic. We all have used this phrase. You hear it in locker rooms, board rooms, class rooms and everywhere in the media. There is something about us that craves the simple answer, and what could be more simple than the key to something important being just one other thing?
David Freedman adroitly covered this human inclination in his book Wrong: Why Experts Keep Failing Us – and How to Know When Not to Trust Them. He posits that the more complicated the system at hand (weather, human biology, the stock market, etc.) the greater the desire for a simple answer. “The key to weight loss is eating grapefruit” is the sort of phrase that would be soothing to a person trying to lose weight. However, the likelihood that one, simple key to weight loss exists is extremely remote. If one did exist, would anyone be overweight?
Turning to the capital markets, we hear this kind of statement on a daily basis. In the last few weeks I’ve heard intelligent people say/write the following:
1) The key to the stock market is Fed policy.
2) The market is only up because of easy money.
3) Gold is sending a strong signal about the future direction of stocks.
4) Because the Dow Jones Industrial Average hit 17,000, the market is poised for a correction or crash.
5) The slowing Chinese economy will hurt U.S. stocks.
6) The market is always strong in a year with mid-term elections.
7) Russia’s actions in the Ukraine will surely bring down the markets.
8) Higher interest rates will hurt the stock market.
9) Stocks are overvalued, so they will go down.
10)There has not been a correction for 2 years, so we’re due.
I’m sure that the reader could recall other similar comments. At their heart, all of these statements contain the idea of “The key to the stock market is ______.” I’m not suggesting that these factors are not important, but rather that any one factor by itself almost never is the reason for the market’s movement. It’s too dynamic and complex to be driven by just one thing. This is one reason market timing (buying and selling “the market” to make money) is so difficult. Imagine all the resources a professional investor has at his or her disposal in the attempt to time or beat the market. Compare that to some “insight” you might have picked up by watching television or reading a newspaper. Is it logical to assume that this one notion really holds the key to the future of the stock market?
I think not.
Exactly because “the market” is so complex, I spend very little of my research effort on it. I focus on individual companies and their valuations. Valuation is not the key to success to investing, but it is one important component of the investment formula. Also, I can add much more value to the process by looking for undervalued stocks rather than trying to time the market.
So far, this approach has been working for me.