“Be fearful when others are greedy & be greedy when others are fearful” – Warren Buffett, 2004 Annual Shareholder Letter
“Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down” – Warren Buffett, 2008 Annual Shareholder letter
This past Monday, February 5th, DOW Jones dropped by 1,175 points – the biggest point drop in history. In percentage terms it declined 4.6% – the biggest decline since August 2011. I don’t think anyone in the market saw this drop coming. In fact, just the past week some of the companies that I track like Apple, Google, Facebook, Amazon reported great quarterly earnings. Apple cash pile now stands at a whooping $285 Billion. Google’s cash pile is just over $100 Billion.
Wall Street pundits are blaming expectations of higher inflation and rising interest rates as the reason behind this fall. They are expecting that the new tax rules and a tight labor market will result in higher wages. Higher wages mean that people will spend more on goods & services thus driving their prices higher. To rein in higher inflation the Fed will have to raise interest rates at a faster pace.
High interest rates are a source of direct competition to stocks. What I mean is – lets say that an investor has to choose between investing in a stock with a dividend yield of 4% per annum and a bond which is offering a risk free return of 3.5% per annum, the investor is more likely to choose the bond because investing in bond carries no risk and is offering roughly the same return as a stock. Thinking about this sell-off from a Macro Economics perspective makes sense. Higher wages will drive up inflation which in turn will drive up bond yields and this change will make investors prefer bonds over stocks.
But how about if we think about this situation from a business owners perspective? From a business owners perspective this is the situation that we have been waiting for since 2008. The economy is getting stronger not just in the US but world-wide economies are doing much better. Wages are increasing which means people will spend more. If you are a CEO of Home Depot or Apple or Starbucks or Bank of America or any other company, this situation augurs very well for your business. Look at Apple, the best-selling iPhone is now priced at over $1,000. It has 1.3 billion installed devices world-wide which means Apple can market its service like Apple Music, iMovies, etc to 1.3 billion people at virtually no cost.
The increase in volatility in the stock markets is also good for banks. The increase in volatility drives up the trading volume which results in higher trading revenues for the banks. As an investor you can take advantage of these events to invest in business that you understand at bargain prices. The key to be successful during these volatile times is to stick to the process of investing. Remember the fundamentals:
- You are not buying a stock. You are buying a piece of a business
- Do not invest with borrowed money. “Never risk what you have and need for what we don’t have and don’t need” – Warren Buffett
- Invest in businesses that you understand. You should be able to understand:
- How does the business make money? What drives the price of its products or services up or down?
- Does the company have a sustainable competitive advantage? Example Boeing – little competition, only few companies in the world can make an airplane. Think about what is so unique about the business that you are interested in? Read these post to understand the importance of competition here and here
- Is the price right? Do the break-even analysis. You can read about it here How to Value a business
A stronger consumer, a stronger economy is good for business. Do the research about the businesses you understand and take advantage of the times when everyone else is fearful. If you don’t have the time to do research about individual companies than just invest in a low-cost S&P 500 fund but invest more when the market drops. America has some of the best businesses that the world has ever seen. Invest and grow with them. Happy Investing!
Please subscribe to the blog, Like it & Share it. Also, please share your thoughts via the comments section below.
Disclaimer: These are my personal views and are for educational purposes only. I am not a financial advisor.I am not recommending any of the companies mentioned in this post.
