The Market is Just a Voting Machine

The Stock Market has a split and erratic personality. Don’t fall for his emotional highs and lows.

In the last ten days, the stock market has been up and then down and then up again. For example, the NASDAQ market has been up five days and down five days. Last week the NASDAQ started down 1.96%, then Tuesday went up 1.67%, Wednesday up 2.0%, Thursday up 3.25% and then dropped 1.59% on Friday. The net result through today for the last ten days is that the NASDAQ is up 2.53%.

During those same ten days the Dow Jones Industrial Average is down -0.72% and the S&P 500 index is up 0.59%. The gold index is down almost 10%. A rational person has to ask the question, “what is going on here?” The answer is that the market is bipolar.

It is helpful for the long-term investor to remember that the market is a voting machine. Short-term investors are either “voting” against a bright future or voting for a bleak future. If the future is bright, they buy. If the future is bleak, they sell.

This is the market’s own unique bipolar disorder. It is characterized by periods of depression and periods of abnormally elevated moods that last hours, to days, to weeks, and sometimes even months. I prefer to invest as if I was using a scale to weigh investments. I am not voting for Microsoft, Amazon, Ford, or Tesla. Rather, I am weighing the long-term potential of each investment. The easiest way to do that is to buy shares of an ETF like VYM, SCHD, or DGRO. I chose those three because they align with a dividend growth model that thinks long-term. Therefore, I can buy shares of VYM or SCHD when the market has a gloomy day and then just smile when the market is having a wild party.

Benjamin Graham and Nathan Winklepleck

Mr. Market is really just other buyers and sellers in the stock market. Some days there are more buyers than sellers. When that happens, prices will tend to go up. Some days there are more sellers than buyers. The reverse happens on those days.

Mr. Market presents you with prices. You can either pay the price or hold off. I choose to put in an offer lower than the current market price on days when the market is going down. If the price per share is $50, and yesterday the price was $50.50, then today I might offer to buy 25 shares at $49.75. I can be patient.

There is no reason to over-complicate things. Mr. Winklepleck rightly observes that dividend growth investing is a very simple approach, but simple does not mean stupid or short-sighted.

Actions for an Investor When the Market is Jovial

There are days when the stock market has euphoric joy and is very cheerful. The only thing I do on those days is sell covered call options. The reason is simple. Those who are cheerful are willing to pay me more for an opportunity, however slight, to buy some of the shares in my portfolio. Sometimes they will be rewarded, but more often than not, I get to keep the premium and they get nothing. In reality, they would have been better off just buying the shares themselves on a day when the market is sullen.

Things to Do When the Market is Morose

When Mr. Market is sullen, gloomy, and pessimistic my frame of mind changes. Now I am a buyer because I want the shares of the fearful pessimists. Rarely do I want to buy shares on a day when the market is up. Of course, Mr. (or Miss., Mrs., or Ms.) Market is so bipolar that he (or she) can be up in a grand fashion in the morning and down in the dumps later that same day.

A Good Resource is the AAII

The American Association of Individual Investors publishes a monthly journal. Each issue is a bit different from the one before, but there is an annual pattern. There is an income tax issue and there is a mutual fund and ETF issue. The tables in the February 2023 ETF and Mutual Fund issue can be most instructive.

AAII Table 3 Performance of 50 Largest ETFs

When you look at a table like this, look for returns during a bad year. Bonds have long been touted as “safe” investments. That wasn’t true in 2022. Notice that both VYM and SCHD out-performed bonds and most of the other stock ETFs in 2022. Why is that? Dividend growth investors think long-term. They don’t panic and sell when everyone else thinks the sky is falling.

SOURCE: AAII February 2023 Journal

AAII Table 1 Performance of Index Benchmarks

Now let’s turn our attention to some major index benchmarks. It is prudent to consider the ten-year returns when we do this. You will see significant differences between the domestic (USA) indexes, the international indexes, and the bond indexes. OK class, which path do you want to be on when you think about inflation and increasing living costs? Hint: It isn’t international and it certainly isn’t bonds. I would argue that you should have money in the S&P 500 large cap index, the MidCap 400 index, and the small cap Russell 2000.

SOURCE: AAII February 2023 Journal

AAII Figure 1 Annual Returns By Asset Class

One final image to drive the point home will help you learn to invest wisely. As you look at each year, read from left to right. The right-most column shows the asset group that performed the best in each year from 2013-2022. Do you see the trend? Now look at the far-right columns. What can you learn from that display of yellow and gray boxes?

SOURCE: AAII February 2023 Journal

If you are a careful student, notice where most of the blue boxes and many of the green and red boxes lie. You should see mostly blue, green and red in the first three columns on the left and mostly gray and yellow on the three right-most columns.

If you think bonds are safe, you might be right in the short-term, but you will be terribly disappointed ten years from now.