Irrational markets: Taking the long view

October 09, 2019

Uncertain economic forecasts. Jumpy stock prices. Financial markets are odd beasts that can be both rational and fickle at the same time. That’s why municipal investors often look warily upon equities.

In theory, security prices should reflect the facts. As new information is digested by the market, security prices should respond. Stock prices may dip on bad news and may bounce on good news, and bond prices typically react differently than do equities. For this reason, investment traders, analysts and investment managers closely monitor the news for items that should influence security prices. Not only do the facts matter, but when and how these facts are released to the public will also impact the prices of securities. In this sense, markets are rational and reflect fundamentals.

In reality it is not that simple. Emotion drives the markets as much as facts. Stock prices will fluctuate all day long, seemingly in the absence of any relevant new information or news. The price fluctuations can seem almost random. Benjamin Graham, who is widely regarded as the ‘father of value investing’ put it aptly:

“In the short run, the market is a voting machine but in the long run it is a weighing machine.”

He means that the markets are like a popularity contest over the short term and may respond to views and emotions rather than fact. This can create significant noise that causes securities prices to diverge in the short term from fundamentals. In the long run, fundamentals and valuations tend to dominate and prices will tend to converge on their intrinsic value. Rationality is sometimes less apparent in the short term but ultimately it shines through.

This underlying truth should drive investment decisions. That is why ONE Investment focuses on solutions that meet municipalities’ long-term needs. Investors need to resist reacting to short-term gyrations in the markets or reacting emotionally to news and other market developments. Instead, municipal investors are advised to review their needs, goals and circumstances and to develop an investment plan that reflects this review. It is all about setting out a plan and sticking with it.  

For most investors it is extremely difficult to outthink the market, but many investors still try to time their transactions correctly to improve returns. Betting that the market will go up or down in the short term often amounts to speculation. Even seasoned investment professionals have problems timing the markets and find it difficult to do this consistently. The better path is to stay steady through market ups and downs.

While Councils can get nervous about short-term gyrations, it’s helpful to reassure them that public dollars aren’t being managed by betting on markets in the moment. Typically, municipalities will have an ‘investment policy statement’ that defines investment objectives and risk tolerance for the municipality. This will guide municipal investment planning towards steady management as opposed to highly active and risky trades. As the municipal investment plan is serving longer term financial goals, it will be well served by rational and professional decision-making.

Investment Planning
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