“All man’s miseries derive from being unable to sit quietly in a room alone.” From time to time, Blaise Pascal’s famous observation receives an airing on The Value Perspective and the opportunity has again arisen – this time in light of the recent questions we have received on how we are reacting to the high levels of market volatility that have persisted since China devalued its currency on 11 August.
As we have discussed in articles such as Something or nothing, the instinct to try and influence events by doing something – anything – may be very human but it is not the way of the value investor. This disconnect is evident from the surprise that greeted our initial response to those questions mentioned above – that August saw us buy just one new stock while our cash position did not move very much.
The point of adopting a value framework is to help take the emotion out of investing and prevent you being swept along with the rest of the crowd when they are selling in fear or buying through greed. The former state has very much been the theme of the last month or so but, without wishing to sound trite, our view is that, if there is time to panic, there is time to think carefully and plan ahead.
Rather than reacting to the recent past, in other words, value investors strive to remember – and, where appropriate, apply – the lessons of history. As such, the questions we have been asking ourselves have related to what has actually changed – given this period of undeniably significant volatility – both in terms of the stocks we own and the wider market.
Looking at China, for example, both its stockmarket and its currency have suffered uncomfortable falls in recent weeks. In neither instance, however, have those falls been enough – at the time of writing, at least – to wipe out the large gains made in the last 12 months or so. The following chart, borrowed from our sister Talking Point site, makes that point graphically on the market front.
Source: Thomson Datastream, Schroders Economics Group. Updated 28 August 2015
To our minds, what we have witnessed so far is the unwinding of a large bubble and yet valuations have not changed so materially as to justify large scale changes to our portfolios. Of course, we do not know what the future will bring – nobody does – but that is why, at the point value investors buy into stocks, they take steps to minimise the effects of market downturns such as we are now seeing.
It is why we look to give ourselves a ‘margin of safety’ by buying companies on very low valuations and with the strength of balance sheet that offers them the best chance of making it through tough times. It is also why we hold a stock for, on average, five years – after all, even after big market falls, such as the financial crisis or dotcom bubble, markets have tended to bounce back relatively quickly.
The key point is that, when the market starts to panic, investors must be able to believe in their process. As value investors we know, if we have followed ours properly, we should not be reacting to past bouts of volatility but instead – confident in both our own margin of safety and the wider market’s propensity to overreact – looking for fresh cheaply-valued opportunities to help see us through future downturns.