Using Short-Term Market Sentiment to Your Advantage- Buffett Example

Understanding market psychology is one of the most essential characteristics to achieving long-term investment outperformance. Firstly, the vast majority of market participants are focused on short-term performance. If you watch CNBC or Bloomberg, you will see this attitude on full display. There are no shows on either network dedicated to long-term investing. How bizarre is that if you really think about it? The reality is that these networks want daily viewers so the advertisers are happy, so there is a vested interest in promoting short-term trading based on news, momentum, technical analysis etc.

What I mean by this is that many people avoid an investment that is obviously undervalued dramatically, because they believe it may drop more due to some short-term issue. Conversely, they will buy a stock that they believe to be overvalued from an intrinsic value standpoint, because they think it will continue to go up short-term. This is really the definition of speculation.

If market participants were consistently able to be accurate in forecasting short-term prices, than this would not be a problem, but the reality is that they are not. This is why most market participants dramatically underperform. Speculating might work for a while, just like you might get hot playing blackjack in Vegas. At some point your luck runs out and there are very few successful professional blackjack players for a reason.

To buy securities that are deeply undervalued, you are almost always going to be dealing with securities that are out of favor for various reasons. Below you will read an excellent article about Warren Buffett’s investment in the Washington Post in 1973. He acquired the obviously undervalued stock at a time when media companies were greatly out of favor. After the first year, he was down 20% on his investment, which is a great example of how little short-term performance means on any actual investment. Over the long-term, it became one of his most successful investments, as he literally made billions out of millions. In today’s market, we are seeing signs of a bubble in various areas. Momentum is ruling the day and optimism reigns with just about every decision made by glamor stocks such as Amazon (AMZN), Tesla (TSLA), and Netflix (NFLX). Even industrials and consumer staples companies are trading at valuations, where you’d have to believe we won’t have a recession for the next decade to come close to justifying their current price. Despite this enthusiasm, there are other industries such as retail that are absolutely hated. Real estate worth many billions of dollars is being valued as though it is worth nothing. Certain healthcare and financial companies are dramatically undervalued and out of favor for various reasons, providing fertile ground for value investors. If you are in an index fund, you are by definition buying mostly the in favor securities at higher prices.That doesn’t strike me as a smart approach given the current environment. I can’t tell you when there will be a reckoning on certain glamor stocks, but I can tell you that it will happen, and you don’t want to be holding the bag when it does indeed occur. I hope that you enjoy the article:

How Warren Buffett Turned $10.6 Million Into $221 Million While Others Were Embracing The EMT