My addition to the Third Option would be: if you know something’s a good company, wait until a cyclical (but fundamentally extraneous to the company’s business prospects) market downturn and buy it while everything is crashing. You almost definitely won’t hit buy while the share price is bottoming out, but once the market recovers and the economy overall continues growing, you will probably get good value for your purchase.
(Of course, this depends on you being cash-flush enough to invest countercyclically! Most people can’t do this, because most people are going to be in personal cash crunches exactly when the market or economy overall goes down.)
My addition to the Third Option would be: if you know something’s a good company, wait until a cyclical (but fundamentally extraneous to the company’s business prospects) market downturn and buy it while everything is crashing.
I think this is basically wrong, because opportunities are time-sensitive. If a company is undervalued now, it’s not obvious it will remain undervalued until the next cyclical downturn, and you pass up on the benefits of any market correction in the valuation of the undervalued company.
I do agree that it makes sense to invest countercyclically (where you have more of your wealth in stocks when you think the stock market is undervalued, and more of your wealth in cash / CDs / etc. when you think the stock market is overvalued), but determining whether the stock market as a whole is undervalued or overvalued is a difficult task, and it takes planning and forethought to ensure you are not cash crunched when the economy dips (which you should do now).
I also think that correctly pricing downturn risks is a subset of correctly pricing shocks in general. How much damage will the oil spill actually do to BP? How much damage will Jobs’s death do to Apple? How much damage will Buffet’s death do to Berkshire Hathaway? How much damage will a general economic downturn do to Apple?
I’m pessimistic on Apple’s prospects without Jobs, because of what I know about his management style, but time will tell how that turns out. I’m optimistic about BRK’s prospects without Buffet, again because of what I know about his management style—and so if the market dips significantly when they take his pulse again, I’ll buy BRK (like I bought BP when the market overestimated the damage). And here we’re in the same sort of situation- if you think that BRK is will grow in both the short-term and long-term, but there’s an upcoming predictable dip (Buffet’s death), do you wait for the predictable dip to buy, just buy now, or split some funds out to buy now and other funds to wait for the dip?
I think this is basically wrong, because opportunities are time-sensitive. If a company is undervalued now, it’s not obvious it will remain undervalued until the next cyclical downturn, and you pass up on the benefits of any market correction in the valuation of the undervalued company.
Disagree. The point is not to pick out undervalued stocks, but to ride the cycles.
If you want to ride the cycles, shouldn’t you just market-time the broad index of your choice? Picking “undervalued” companies to ride the cycles implies that you have two skills (which, I think, are mostly orthogonal) -- the stock-picking skill and the market-timing skill.
My addition to the Third Option would be: if you know something’s a good company, wait until a cyclical (but fundamentally extraneous to the company’s business prospects) market downturn and buy it while everything is crashing.
This assumes that you can generally beat the market by buying stocks when you think there a market downturn and selling them when you think the market as a whole is high. This assumes that the efficient market hypothesis is wrong on a fundamental level.
Well, the Efficient Market Hypothesis is wrong on a fundamental level—its stated conditions for market efficiency often fail to prevail in the real world. Panics are one of those times, and being more rational than other people is not a free lunch, but in fact a Substantial Effort for Good Return Lunch.
(I’ve seen one paper actually proving, rather humorously, that EMH is completely true IFF P = NP.)
My addition to the Third Option would be: if you know something’s a good company, wait until a cyclical (but fundamentally extraneous to the company’s business prospects) market downturn and buy it while everything is crashing. You almost definitely won’t hit buy while the share price is bottoming out, but once the market recovers and the economy overall continues growing, you will probably get good value for your purchase.
(Of course, this depends on you being cash-flush enough to invest countercyclically! Most people can’t do this, because most people are going to be in personal cash crunches exactly when the market or economy overall goes down.)
I think this is basically wrong, because opportunities are time-sensitive. If a company is undervalued now, it’s not obvious it will remain undervalued until the next cyclical downturn, and you pass up on the benefits of any market correction in the valuation of the undervalued company.
I do agree that it makes sense to invest countercyclically (where you have more of your wealth in stocks when you think the stock market is undervalued, and more of your wealth in cash / CDs / etc. when you think the stock market is overvalued), but determining whether the stock market as a whole is undervalued or overvalued is a difficult task, and it takes planning and forethought to ensure you are not cash crunched when the economy dips (which you should do now).
I also think that correctly pricing downturn risks is a subset of correctly pricing shocks in general. How much damage will the oil spill actually do to BP? How much damage will Jobs’s death do to Apple? How much damage will Buffet’s death do to Berkshire Hathaway? How much damage will a general economic downturn do to Apple?
I’m pessimistic on Apple’s prospects without Jobs, because of what I know about his management style, but time will tell how that turns out. I’m optimistic about BRK’s prospects without Buffet, again because of what I know about his management style—and so if the market dips significantly when they take his pulse again, I’ll buy BRK (like I bought BP when the market overestimated the damage). And here we’re in the same sort of situation- if you think that BRK is will grow in both the short-term and long-term, but there’s an upcoming predictable dip (Buffet’s death), do you wait for the predictable dip to buy, just buy now, or split some funds out to buy now and other funds to wait for the dip?
Disagree. The point is not to pick out undervalued stocks, but to ride the cycles.
If you want to ride the cycles, shouldn’t you just market-time the broad index of your choice? Picking “undervalued” companies to ride the cycles implies that you have two skills (which, I think, are mostly orthogonal) -- the stock-picking skill and the market-timing skill.
Fair enough, although I would generally say to pick the stock via fundamentals and industry-specific knowledge.
This assumes that you can generally beat the market by buying stocks when you think there a market downturn and selling them when you think the market as a whole is high. This assumes that the efficient market hypothesis is wrong on a fundamental level.
Well, the Efficient Market Hypothesis is wrong on a fundamental level—its stated conditions for market efficiency often fail to prevail in the real world. Panics are one of those times, and being more rational than other people is not a free lunch, but in fact a Substantial Effort for Good Return Lunch.
(I’ve seen one paper actually proving, rather humorously, that EMH is completely true IFF P = NP.)