2016 Economic & Stock Market Preview
As we have already turned the clocks back in New England and are now making our way towards the “short” days of winter (the least amount of daylight in Boston occurs on December 22 this year with daylight lasting 9:04:34 in contrast to the “longest day” of 2016 on June 20 in which daylight will last for 15:17:05), it is once again an appropriate time to reflect upon the year that was and opine upon our thoughts for the upcoming year.
And the Winner Is…
In 1936, famed economist John Maynard Keynes wrote his seminal work entitled The General Theory of Employment, Interest and Money.[i] Within one of the chapters, Keynes described a hypothetical newspaper contest in which readers would be shown 100 photos and would be asked to pick the six best looking girls. Prizes would be awarded to the readers who chose the girls whom readers voted for most often. Some individuals would automatically flip through the photos and pick the girls that they thought were the prettiest in order to attempt to win. However, the contest would not reward those who picked the best looking girls, but the most popular. Beauty is always in the eye of the beholder. Therefore, it would benefit contestants to attempt to predict which girls the average entrant would consider the prettiest. Even more so, a contestant could recognize that other entrants would have different beliefs on what public perceptions are and attempt to forecast the winning combination based on this line of reasoning that was one more layer removed from the process. Keynes created this hypothetical contest in order to make an analogy to the stock market: in the short run, attempting to outperform requires speculators to attempt to predict which stocks will be popular with other investors, not what the underlying performance of those companies will be. Similarly, the father of value investing, Ben Graham, noted this difference when he stated that “in the short run, the market is a voting machine but in the long run, it is a weighing machine.” Over the short term, stocks can deviate from their justified intrinsic value because of the perceived exuberance or fear of investors.
An important investment lesson to learn from this contest is that it is not enough to think in the subsequent manner: this company has the best product or the fastest growth so I should buy its stock. It is imperative to understand the fundamentals of the business and the valuation of the stock. Some stocks trade at high multiples for justified reasons while some stocks trade at low multiples also for justified reasons. However, at times there can be mispriced assets. With stocks, what is unpopular now may turn out to be the best long term investment. What types of stocks are unpopular now? U.S. multinational companies and energy stocks are both losing the popularity contest in 2015.
[i] Maynard Keynes, John. 1936. The University of Adelaide. 12 Nov 2015. <https://ebooks.adelaide.edu.au/k/keynes/john_maynard/k44g/index.html.>