Over the past two decades, the economy and financial markets have experienced three seminal events which amplified age-old behaviors of individuals reacting to basic emotions of fear and greed in the investment markets.
These events were the Dotcom Boom and Bust of 2000, the mortgage-backed housing boom that preceded the Great Financial Crisis of 2008, and now the extraordinarily rapid bust-and-boom of the 2020 Covid-19 pandemic.
All three events led to huge infusions of liquidity into the markets from the Federal Reserve (Fed), as well as significant changes in government policy, regulation, and the structure of the capital markets themselves. These events even contributed to changes in the political dynamics of the country.
They also helped to usher in new types of investment assets, strategies or vehicles that can be characterized as having significant speculative dimensions.
In the aftermath of the Dotcom Bust and Great Financial Crisis events, the value of solid fundamental investing practices again became manifest, and long-term, disciplined investors continued to enjoy the “magic” of compounding returns in building wealth.
As the Covid-19 pandemic event winds through its own unique path – with its own elements of speculative activity – the value of maintaining a solid fundamental investing orientation will again be evident.
Investing in the current environment
The recent confluence of rapidly developing technology, social media, historically low interest rates, and extremely low-cost brokerage platforms has helped to create an environment in which a substantial number of market participants are focusing on the pursuit of speculative, short-term trading profits rather than a methodical long-term approach to building wealth. (See: Fun and GameStop)
New asset types and investment vehicles such as cryptocurrencies, leveraged ETFs and special purpose acquisition vehicles (SPACs), to name a few, have been created in response to this speculative dynamic in the markets. The dramatic growth in video gaming and online gambling – not to mention the relentless “breaking news” orientation from the financial media – has also contributed to this increasingly edgy, restless and, at times, volatile environment.
Rapid-fire equity sector rotation, high frequency trading, “meme stock” trading, cryptocurrency trading, and arcane equity derivative strategies are just a few examples of the current manifestation of behaviors that react and respond almost entirely to the price action of an asset rather than to any assessment of its fundamental value. At its worst, this behavior is simply FOMO (fear of missing out). The common theme of this environment is the focus on trading, not investing.
Trading does provide a valuable contribution to healthy financial markets, if pursued by individuals and organizations in a knowledge-based, disciplined and ethical manner. Trading provides benefits to financial markets in the form of aiding in price discovery and providing liquidity for both investors and other traders. However, when trading is being pursued without real knowledge, or worse, with the mistaken assumption of knowledge, it becomes basically a form of gambling. And as the saying goes, in gambling, “the house always wins!”
Investing also needs to be pursued in a knowledge-based, disciplined and ethical manner. It is the process of carefully assessing a rising tide of information, with the use of data analytics, to determine opportunities and risks for various industries and companies.
However, real investing has a much longer-term orientation than trading. It leverages a longer time horizon as an opportunity, not a time clock that needs to be beat. Consequently, this longer-term dimension provides the powerful advantage of time for an investment to benefit from either organic growth or from positive changes occurring in specific industries, or from positive management changes that a company makes to improve its performance.
By contrast, many trading approaches are based on ephemeral valuation idiosyncrasies, price momentum or short-term arbitrage opportunities.
Focus on the main event – not the sideshow
Speculative activity that revolves around trading, although potentially interesting due to its immediate results, both good and bad, is the sideshow of the investment markets. The main event of investing should focus on the following key, long-term elements:
- Long-term investing in the equity of quality companies, regardless of capitalization size or growth/value dimension, remains the best approach to wealth building. The composition of industries and companies may change over time, and business models and asset composition may change, but investment value is still constructed from the dynamic interplay of growth, profitability and return on capital.
- Although it is widely understood that knowledge is power, given modern communication technologies, knowledge is almost instantly disseminated across the markets and digested. However, it is knowledge combined with process, patience and perseverance that leads to powerful investment success.
- Ignore the growing noise in the world and the markets, but always be open to incorporating new information and analyses. The explosion of new data and the ability to rapidly process and analyze it in potentially new ways can yield significant benefits.