Mr. Market and Risk

Are the markets panicking?

The stock market has declined almost 20% from its recent high. A lot of European markets—like Germany, France, and Italy—are down over 30%. The markets are pricing in a severe recession in Europe and financial contagion over here.

The main issue is the uncertainty associated with these problems. This has caused investors to raise the return required from stocks, which has lowered stock prices. By the same token, should the EU and IMF favorably resolve their debt crisis, that would remove a large source of uncertainty from the market and shares could rise 10-15%.

Beyond these short-term concerns lies a more significant issue, however. Benjamin Strong once noted that in the short run the market is a voting machine, where the votes counted reflect the dollars of the participants but no sense; in the long run, though, the market is a weighing machine. Imagine, he noted, that you have a business partner named Mr. Market who, every day, offers either to buy you out or sell you more of your holdings. Mr. Market is a moody fellow—some days he’s depressed, other times he’s maniacally elated.

Right now, Mr. Market is down in the dumps. He’s ignoring the fact that employment has been steady, incomes have been steady, consumer spending is growing, and trade continues to grow. Mr. Market is listening to what people say, not watching what they do.

Fear is understandable when facing uncertainty, but investment decisions need to be based on long-term issues, not yesterday’s news. And panic is not a strategy.

Douglas R. Tengdin, CFA
Chief Investment Officer
Hit reply if you have any questions—I read them all!

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