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Share market madness – and an antidote

Stock indices are moving like rudderless yachts – being blown around by the prevailing winds. A gust of bad news, and the market drops. A kinder breeze of good news leads the market to breathe a collective sigh of relief, and the indices rally 1% or more.

I’m not going to sugar-coat it – this is utter madness!

All care, no responsibility

Short term swings like these are effectively the market as a whole simply abdicating responsibility – substituting emotion for fact. It’s irresponsible and it’s wealth-destroying. And, since the dawn of stock markets, it’s ever been thus.

Long ago, Sir Isaac Newton summed up the situation, saying “I can calculate the movement of the stars, but not the madness of men”.

There is no single fact or set of facts that can be plausibly, rationally, responsible for the gyrations we’ve seen recently. There is no rational reason for the market to chop and change its view from sell, to buy and back to sell in the space of 24 – 48 hours. But that is exactly what the market – as a whole – is doing.

Sea sick in a choppy market

On one level, this phenomenon is incredibly frustrating.

The Motley Fool believes in individuals taking control of their own investing futures, and seeing many scared out of the market – and potentially costing themselves real money in the process – is disappointing. Whole groups of investors, inflicted with a case of stock market sea sickness, have rushed for the ‘safety’ of solid ground.

While less volatile, this strategy – usually typified by forsaking growth investments for the certainty of cash – has proved in the past to leave investors with a seriously sub-par result. In the words of the standard disclaimer, past performance is no guarantee of future results, but I don’t think an after-inflation return of 2-4% is likely to beat shares over the medium and long term.

Don’t let the market’s moods own you

On the other hand, investors who can get their heads around the current skittishness in the market can use this phenomenon to their advantage. Economists had long believed in explaining human decision-making by (incorrectly) assuming people were rational, emotionless and always acted in their own best interests.

Modern day economists have a term for the reality – behavioural finance. It embraces and explains irrationality, and tells us to expect it. Moreover, it gives us a framework to fight our irrational selves.

At times of fear – due to economic uncertainty, recession, war or serious inflation, investors became very pessimistic. Unable to see beyond the end of a downturn, many investors dump stocks at low prices, or are too scared to buy until the opportunity has passed them by. Others, taking a longer view, see the buying opportunity that these periods present.

We’ve been here before

For my money, we’re in one of those periods now. In the see-sawing market of 2011, the proverbial babies have been dispatched with the bath water. Sparing almost no-one, uncertainty has hit even the highest quality businesses.

And when I say ‘for my money’, I mean it. I’ve been putting excess cash to work over the past few months, picking up shares in great quality, stable, well run businesses while they’re at depressed prices.

In short, I’ve taken advantage of the opportunity to buy great businesses while they were on sale.

Specifically, I’ve been buying Woolworths (ASX: WOW), QBE (ASX: QBE) and the US-listed Berkshire Hathaway at valuations (and prices) not seen in years.

Woolworths is trading at prices not far above those of early 2007, and with a trailing dividend yield of almost 5%. QBE, caught in the downdraught of falling US interest rates, is a tiny fraction from a 10% trailing dividend yield and the lowest prices in around 7 years. Berkshire Hathaway, the investment vehicle of super-investor Warren Buffett, is trading at its lowest multiple of book value in many, many years – despite Buffett’s unparalleled history and the superior collection of businesses in the Berkshire Hathaway stable.

Foolish take-away

I don’t know if these stocks are at their low points. It’s probable that one or more of these companies will trade lower in the coming months. Picking lows is pretty much impossible, and you can’t know if you’re right until well after the fact.

I am confident, however, that I’ve bought great businesses at attractive prices – if I can do that often enough, I’m pretty sure I’ll outperform the market over the long term.

Are you worried about the state of the markets right now? Get the Fool’s latest free guide, Read This Before The Next Market Crash. Click here to sign up for your free copy.

Scott Phillips owns shares in Woolworths, QBE and Berkshire Hathaway. This article has been authorised by Bruce Jackson. The Motley Fool has a mighty fine disclosure policy.


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