The stock market’s 40%+ rise since its March lows is likely to have caused a variety of reactions among different investors.
Some investors may now be anticipating a stock market crash as a result of what they deem to be unsustainable valuations. Meanwhile, other investors may be feeling increasingly optimistic about the market’s prospects.
However, the most effective strategy for investors to adopt could be to follow Howard Marks (Trades, Portfolio)’ lead in remaining self-disciplined. The Oaktree Capital co-founder’s ability to avoid the temptation of trying to predict the future could be a central reason for his long-term outperformance of the stock market.
Trying to predict the future
The stock market’s exceptional recent gains do not necessarily mean that they will soon come to an end. Previous bull markets have frequently lasted for longer than many investors expected, and have sometimes continued to rise long after valuations reached excessive levels.
Predicting the stock market’s future performance is impossible. Therefore, you may be better off avoiding trying to estimate how stock prices will perform, and instead focus on viewing stocks as businesses. This may enable you to unearth potential mispricings of sound companies that can produce resilient earnings growth in the long run.
Marks has previously discussed the difficulty in trying to time the end of a bull market: “’Prices are too high’ is far from synonymous with ‘the next move will be downward.’ Things can be overpriced and stay that way for a long time . . . or become far more so.”
Following the investment herd
Recent stock market gains may cause some investors to feel unsure about how to allocate their capital efficiently. This could lead them to follow the actions of their peers, rather than making their own decisions about which stocks to buy or sell.
However, following the investment herd may lead to disappointing returns. Often, investor sentiment moves in tandem with the stock market. This may mean that you end up overpaying for stocks that narrows your prospects of generating high returns.
A better idea is to remain self-disciplined, in terms of ignoring the views of your peers and conducting your own analysis to determine how to apportion your capital. This may mean that you go against the investment consensus. However, it may increase your chances of avoiding overpriced stocks, and of purchasing undervalued companies.
As Marks once stated, “What the wise man does in the beginning, the fool does in the end.”
Focusing on risk
Rising stock prices can cause investors to overlook potential risks facing the stock market. Instead, they may become more interested in the potential for rewards. This may be an unwise strategy due to the significant risks faced by the economy at the moment that could quickly derail its recent gains.
Contemplating the risks to a stock’s future performance is a difficult task. It’s arguably even more challenging at the moment as a result of the unprecedented circumstances facing the economy.
However, investors who factor potential challenges facing a company into its valuation and demand a margin of safety to take account of them may be better able to allocate their capital efficiently.
As Marks once said, “Risk is incredibly important to investors. It’s also ephemeral and unmeasurable. All of this makes it very hard to recognize, especially when emotions are running high. But recognize it we must.”
Read more here:
- Warren Buffett on the Fear of Missing Out After Stock Price Gains
- Peter Lynch on Managing Loss-Making Positions
- Benjamin Graham on the Importance of Being a Rational Investor
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