I was recently listening to a couple of experienced analysts give their thoughts on the current state of the Australian share market. Employing some market jargon, both agreed the market was looking for a 'catalyst' to move from its current level.
In layman's terms, they were suggesting that investors may not currently have a strong view about which way the market would move in the short term, and were waiting for the 'catalyst' – some new fact, rumour or piece of news – to let them know whether they should buy or sell.
The interesting thing was that one of them was looking for a catalyst that would move the market higher, while the other was expecting a move lower.
So in summary – the market wouldn't move unless there was some 'event' – and when it did, it would absolutely, certainly be up… or down.
If you've spent any time with the Fool, you'll know that Fools as a breed are long-term investors – not market timers. But reflecting on that snippet of a longer conversation did provide a couple of key insights.
The Madness of Men (and Women)
The first thing that dawned on me was that they were probably on to something. Don't worry – I haven't just traded in my jester's cap for the Fool's new ZippyTrade 2000 – but they might just be right.
Sir Isaac Newton, who himself was caught up in the South Sea Bubble of 1720 was quoted as saying he could '…calculate the movement of the stars, but not the madness of men'. Unfortunately, he was – and still is – right.
Evolutionarily, humans are predisposed to respond to the most recent stimulus we encounter, and never mind moderation. In investing, this means the latest piece of news or gossip. It takes a decent lick of willpower and self-discipline to ignore the noise.
Investors are an understandably nervous lot, with large chunks of their net worth in the stock market. And as a group, they can be easily caught up in market moods of optimism and pessimism.
'What if the market is dropping and I don't get out?'
'What if the market is booming and I miss out'?
So the analysts I referred to above are probably right – a short term catalyst may just drive a short term move in the market. We know that's probably right, as it has been throughout history from as recently as the Japanese earthquake and tsunami, and as far back as the South Sea Bubble.
The trick for investors is keeping the eternal advice in mind – 'this too shall pass'. Once investors recover from the short term gyrations, it is inevitably the fundamentals of a business that will be the arbiter of value for its shares.
Your Portfolio isn't 'the Market'
The second insight I gained from reflecting on that conversation was that when talking about 'the market', we are simply referencing an index – a number that represents the sum total of the companies selected to be part of that arbitrary group. Now there are ways to 'invest in the index', sure, but most investors use these indexes simply as a reference point with which to compare their medium- and long-term results.
When 'the market' is up or down on a daily or weekly basis, it is simply a reflection of the aggregate mood of all those who traded in the market during that day or week. And as Sir Isaac noted, perhaps that's not the most reliable short-term measure of investing success.
Over the medium to long term (ideally measured in years, not months), indexes such as the S&P/ASX200 or All Ordinaries in Australia, the Dow Jones or S&P500 in the US, the FTSE 100 in the UK or the Hang Seng in Hong Kong can be useful benchmarks against which an investor can measure their own performance.
It makes a lot of sense to periodically review your portfolio against something specific to help you understand your successes and failures, and to learn from them.
Keep Your Eyes on the Horizon
A few years ago, when I was learning to ride a motorbike, the instructor reminded the class to look to where you wanted to ride – not the ground directly in front of the bike. There's a lesson there for investors.
Next time you see a report that the market was up (or down) 20 points or 0.5% the previous day, or that some short term piece of news 'lifted the market' do yourself a favour… just shrug, move to the next story and keep your eyes on the horizon – this year's peaks and troughs will be almost completely irrelevant in the context of a lifetime of long-term investing.