Anxiety has increased as investors digest the debt crisis in Greece and the Chinese market crash. Add the Fed’s rate hike and drop in oil prices to the mix and the outlook is depressing. I started searching for good news – a silver lining amid the chaos – and found more uncertainty and trepidation. I tuned the scaremongers out long ago; you can only cry wolf so many times. It’s the sage investors with decades of experience whom I turn to for an encouraging morsel when all else fails. Now, even the most well-renowned investors are using a cautious tone. In fact, pessimism is running so high it would be difficult to find anyone not expecting a market correction on the horizon. Finally, a sense of calmness fell over me; and a little excitement. Emotional investors drive the market up and down like a yoyo which provides an opportunity to buy solid companies at a discount. The discount helps, but I can confidently invest during tumultuous times for two reasons. First, I do not share the view that volatility and risk are one in the same. Second, rather than blindly throwing money at an index fund, I try to understand the companies I invest in and assess the specific factors that impact each business.
Volatility is academia’s convoluted attempt to quantify risk. Personally, I cannot wrap my head around the theory. When I invest, I am most concerned about losing money, forever. I racked my brain for examples of permanent loss but Howard Marks explains it better than I ever could. To lose money permanently, either the company goes out of business or the investor sells during a downturn. I assume a company going bankrupt would be volatile but the only way volatility leads to permanent loss is fear-induced selling. The notion that fluctuating stock prices are a gauge of riskiness seems ludicrous; underlying business fundamentals don’t fluctuate near as rapidly. When prices fluctuate upwards, no one gripes about the risk. There are many types of risk and all are important to consider but the degree to which a stock’s price moves up or down in a short period of time is not a risk. Companies do not go out of business because of volatility but this concept alone is not enough to prevent panic.
Understanding what you invest in is the best defense in a volatile market. Investors in businesses that sell commodities surely are aware that commodity prices fluctuate. Oil prices, for instance, have moved about wildly for decades. In my mind, that is not a risk that would impact my investment. The risk is the company, during a commodity down cycle, might not be able to pay its debts or keep the business operating. If the underlying business is sound and management is capable of navigating the downturn, the lower share price represents an attractive opportunity. A Greek bank, on the other hand, does face meaningful risks that could lead to bankruptcy. Volatility does not present risk in either example – it isn’t the volatility that scares me in owning a Greek bank, it’s that it could very quickly become insolvent!
If every investor focused on the specific risks facing each company, the market would be far less volatile. Think about how many businesses have nothing to do with Greece; or China for that matter. Yet they all start to move in tandem when fear takes over. Be selective, understand your companies and enjoy the sale.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine what is appropriate for you, consult a qualified professional. Investment advisory services offered through CWM, LLC a Registered Investment Advisor.