Have no fear of stock market unrest

In the Financial Analysts Journal over 40 years ago, Charley Ellis of Greenwich Associates famously characterized money management as akin to a game of amateur tennis in which success is not due as much to how many points one wins with great shots, but how one avoids losing points by making bad shots. Even at the professional level, unforced errors are the bane of the tennis player. Adherents of passive investing avoid playing the losing game by minimizing fees and trading costs.

To a large extent, politics is also a losing game. Donald TrumpDonald John TrumpBiden says his faith is 'bedrock foundation of my life' after Trump claim Coronavirus talks on life support as parties dig in, pass blame Ohio governor tests negative in second coronavirus test MORE and his senior administration officials continue to undermine his own presidency with a series of unforced errors occurring at a pace greater than his grammatical errors in his daily tweet storms. The time worn finance adage is that the market “hates uncertainty” and while it is difficult to catalogue all of the missteps of the administration, from the partial government shutdown to the resignation of Defense Secretary James MattisJames Norman MattisTrump advisers were wary of talking military options over fears he'd accidentally start war: report Trump prizes loyalty over competence — we are seeing the results Lawmakers torch Trump plan to pull 11,900 troops from Germany MORE, and the trade war with China to spats with the Federal Reserve, and Treasury Secretary Steven MnuchinSteven Terner MnuchinCoronavirus talks on life support as parties dig in, pass blame On The Money: Pessimism grows as coronavirus talks go down to the wire | Jobs report poised to light fire under COVID-19 talks | Tax preparers warn unemployment recipients could owe IRS Top Democrats say postmaster confirmed changes to mail service amid delays MORE calling bank executives in an effort to reassure the market that there is no liquidity crisis, the list expands on a daily basis.


The market experience in recent weeks reminded investors of the movie “Groundhog Day” in which a weatherman played by Bill Murray finds himself living the same day over and over again. The market opens flat, there is an morning to afternoon rally, and then a rash of selling sends the indexes lower at the close. Lather, rinse, repeat. The nearly 3 percent selloff in the Dow Jones Industrial Average on Monday in a shortened session led to many conversations about the market around holiday dinner tables. Is a recession on the horizon? Is it time to sell stocks? The market bounced back on Wednesday, with the Dow Jones Industrial Average surging almost 5 percent, in yet another whipsaw.

It is the season for pundits and prognosticators to share their various expectations for global financial news. What I told my dinner companions this season is that I have no earthly idea what is going to happen in the market in the next day, week, month, quarter, or even year. In 2009 during the height of the financial crisis, Warren Buffett was quoted as saying, “We have long felt that the only value of stock forecasters is to make fortune tellers look good.” He then added, “I continue to believe that short term market forecasts are poison and should be kept locked up in a safe place, away from children and also from grown ups who behave like children.”

Benjamin Graham, the father of value investing and mentor to Warren Buffett, explained the concept of value investing by saying, “In the short run, the market is like a voting machine, tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine, assessing the substance of the company.” Sentiment drives the market in the short run, while fundamentals drive the market in the long run. Sentiment has been decidedly negative and understandably so, but the fundamentals tell a much different story. S&P 500 earnings grew at an astounding 27 percent pace in 2018. While earnings growth is expected to slow to 6 percent in 2019, earnings are still expected to grow. Looking further ahead, earnings are expected to grow about 13 percent in 2020.

The metric that is most commonly used by investors to ascertain market valuation is the price earnings ratio. The lower the price earnings ratio, with all else equal, the greater the margin of safety for investors. For those who say the market is in a bubble, the current price earnings ratio is actually lower than the historical mean of 15.7. The forward price earnings ratio on the S&P 500 is currently 15.1, compared to 25.3 a year ago. The market has actually gotten about a third less expensive over the past year.

For long term investors, the market appears to be attractively priced, particularly when the yield on the 10 year Treasury note is 2.75 percent. Stocks and bonds compete for investors. Essentially, investors can buy the S&P 500, a broad basket of companies with growing earnings and dividends, at a forward price earnings ratio of 15.1, or they can buy the risk free 10 year Treasury note at an implied price earnings ratio of 36.3. I may not have a good feel for what the market is going to do in the near term, but if one has a long term horizon, the S&P 500 is the clear winner.

Unsurprisingly, viewership of financial cable news spikes during market turmoil. Nervous investors want to know what moves they should be making, and talking heads on these networks are quick to offer a variety of remedies, generally delivered with a great deal of conviction. The most prudent move is usually to do nothing. When behavioral finance expert Greg Davies was invited on Bloomberg to talk about the market rout in 2008, he was asked what investors should do if they are really worried. He replied, “They should stop watching Bloomberg for a start.” Are the gains on Wednesday the start of a new uptrend or a prelude to more turmoil? Who knows? Investors should listen to Greg Davies and tune it all out.

Robert R. Johnson is a finance professor at the Heider College of Business at Creighton University. He is the chairman and chief executive officer of Economic Index Associates and an author of “Strategic Value Investing.”