Prices Can Be Distorted by Computer Driven Trading
Last year’s fourth quarter downturn started as short-term interest rates increased, which made bonds more of an investment alternative to stocks.
At the same time, concerns over stocks were rising, as investors worried about a somewhat elevated market valuation of 17.5 times expected 2019 earnings, the threat of a trade war and higher tariffs, and potential economic weakness partially due to the prospects for a trade war. This led to the anxiety and market downturn, but our view is that the market isn’t nearly as overvalued as it was before the downturn that started in in 2000, and the economy and banking system appear to be in much better shape than they were in the 2008 downturn notwithstanding the trade concerns.
The speed and magnitude of the recent downturn probably was exacerbated less by fundamentals and more by the fact that a much higher percentage of today’s trading, as much as 85 percent, is driven by models, machines and passive investing, all of which are momentum-based.
During times like these, you should consider the strong possibility that the short-term prices for many of the stocks you own are being set by the most nervous investor and can be completely detached from the true value of the business, valuations which will eventually be evident regardless of the current turmoil. That is no time to sell, particularly since long-term appreciation in your portfolio is so difficult to achieve by being in and out of the market.
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