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Passive vs. Active Management:
How to avoid the mood-swings of "Mr. Market"
[Download Printable White Paper]
Analysts often use colorful images to explain how the
markets work
or why a particular index or asset class
is "behaving" in a certain way.
We'll hear references to the "Goldilocks" economy,
a Santa Claus rally, tigers and tea leaves, bubbles and
roller-coasters. A single adjective in a Fed speech
may dominate headlines and drive speculation for two
days running.
This sells newspapers and gets ratings. But the danger
is that in over-simplifying an analysis, it becomes
simplistic almost without decision-making value.
Today's round-the-clock news cycle demands a
talking-head rationale for every minor indigestive day
in the market. It seems even the slightest 20-point
movement must be attributed to something: obscure
remarks by a finance minister or an after-hours rumor
about labor negotiations in Detroit.
In this media environment the Dow, the S & P 500 and
other indexes acquire quasi-human characteristics,
as if they were capricious Greek gods.
As you watch television and read the papers, notice
how often these statistical indices are subtly endowed
with feelings or moods: the market "has an appetite" for
energy stocks on Monday, the market is "panicked" by
a Labor Department report on Tuesday, the market
"doesn't like what it heard" in a speech on Capital Hill.
Some of this is journalistic license, of course. But it
contributes to and reflects a "what-is-the-Dow-doing-
today" obsession among investors with
actively-managed portfolios, a chronic anxiety level that
has sabotaged many a program.
Often you'll hear the anthropomorphic mantra "the
market is always right." This attributes some innate
"wisdom" to an index. Even the godfather of all analysts,
Adam Smith, famously coined a metaphorical reference
to an "invisible hand" an often-misunderstood allusion
to macro-economic forces, not to stocks.
Fact: the stock market is not a person (nor is it a god!).
Personification of the market resulting so often in
the downfall of investors who try to predict or time its
behavior was superbly satirized by a man whom many
call the father of value investing, the Columbia
University economist Benjamin Graham. He was such
a pioneering influence that two of his most famous
disciples, Warren Buffet and Irving Kahn, named sons
after him.
It was Graham who invented the bi-polar, emotionally
disturbed character he called "Mr. Market."
(cont.)
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