Carpe Diem, Patiently
The key is to have a long-term focus and price target. Be patient, wait for the appropriate risk vs. return parameters, and then move with confidence to establish or exit a position. Having a long-term focus increases the ability to act with conviction in the short-term.
The Growing Herd of Traders
There are several long-term trends in the market driving more investors to join the thundering herd of traders, and abandon the long-term market view of investors.
Institutional investors are focusing more on short-term trading strategies due to:
1) Institutional and high net worth investors have embraced hedge fund structures that pursue shorter term trading strategies. These funds can have trading time horizons of days or even hours.
2) Algorithmic strategies that can read headlines to trade to earnings beats or misses and changes in company guidance.
3) Quantitative trading funds, that eschew fundamental valuation parameters and focus instead on stock charts and intra-day trading momentum. Quant and algo funds that rely on chart moves will accelerate buying and selling as short-term trends emerge, exacerbating upside and downside volatility.
Individual investors are pursing shorter-term strategies due to:
4) The rise of zero commission equity trades lowers the cost to a trader of flipping in and out of a position.
5) The use of pre-tax retirement accounts as brokerage accounts for short-term trading. Pre-tax accounts shield traders from short-term trading capital gains.
6) The continued growth of mainstream and social media focused on individual investors. TV networks and social media sites continue to expand content and clubs to draw in more individual investors, much of which focuses on the current hot trends or stories in the news.
Short-term strategies typically don’t rely on valuation, which is what we see as the key factor in successful investing, but instead on how quickly one can react to a perceived change in either a macroeconomic or company specific change. Short-term traders believe that they can invest faster than peers, and in our view erroneously rely on confirmation bias of short-term price moves to accelerate their trading moves.
Musical Chairs?
We see short-term trading strategies as akin to the childhood game of musical chairs, mainly in the fact that when the music stops, someone will lose. Without a focus on what the long-term value of an investment is, short-term traders completely lose their thesis for owning a position when the momentum exhausts – and then the race to exit the trade begins. The race to exit can turn into a rushed panic as chart patterns reverse. Slow moving traders, usually the individual investors, can get crushed by the trading herd as it rapidly changes direction.
“Are You Interested in Return on Capital or Return of Capital?”
I have been lucky to work for and learn from three renowned investing gurus, Laura Sloate, Jerry Cramer and Marty Whitman. The quote above is from Jerry Cramer and in our view completely sums up what is missing in trading strategies, that is the answers to the two questions of i) what is the investment worth? and ii) what is your return if you buy it at current prices?
How Should Long-Term Investors View Today’s Markets?
We have always focused on three investment pillars that support a long-term investment horizon, i) a strong balance sheet, ii) the ability to grow, defined as the ability to achieve a return on capital over the cost of capital, and iii) a significant and investible discount in today’s price vs. our estimate of fair value.
In our view, when macro or company specific news hits the market, we don’t ask ourselves if this could cause a quick price pop or drop, but instead if the news changes our established long-term price target derived using the three parameters above. In our experience, for the vast majority of short-term news tidbits, the answer is no, the fundamentals and our price-target are unchanged.
Investing at the Advantage of Traders – Increased Patience, Increased Aggressiveness
The strengths of a well-researched investment and the establishment of a fundamentally derived price target can, in our view, create opportunities to profit from the short-term pops and drops in stock prices. The key is patience and time-horizon. When we see large short-term moves in stock prices, we take Jerry Cramer’s advice and measure the potential return on capital. Simply put, if the short-term traders drive a price down to the point of a compelling return vs. our two-to-three year price target, we can use that move as a compelling point of entry. Likewise, when a bullish upside pop pushes a stock to our target, we trim back and/or exit our position, with the view to redeploy the capital to better risk vs. return opportunities.
Investors Should Thank Traders
What the rise of trading strategies has brought to long-term investors is the gift of time – that is, in many cases the short-term buying pushes our investments to price targets in periods much shorter than our two-to-three year horizon, and we sell. Likewise, when short-term traders push down the price of an investment to the point where the two-to-three year upside return potential creates an attractive buying opportunity, we Carpe Diem, aggressively.
Rewey Asset Management is a registered investment advisor in the State of New Jersey
This material is for informational purposes only and is not a recommendation or advice. Investments and strategies mentioned are not suitable for all investors. No one can predict or project performance, and forward-looking statements are not guarantees. Past performance is not indicative of future results. Investing involves risk, including the loss of principal.