In his latest memo titled – Mr. Market Miscalculates, Howard Marks discusses how the market is driven by emotional, volatile investors who buy high during good news and sell low during bad news, causing prices to fluctuate significantly. However, only a small number of participants can create these dramatic price swings.
He recommends investors resist joining these irrational behaviors and instead remain calm, understanding that these fluctuations often stray from a company’s intrinsic value.
Here’s an excerpt from the memo:
The market fluctuates at the whim of its most volatile participants: those who are willing (a) to buy at a big premium to the former price when the news is good and enthusiasm is riding high and (b) to sell at a big discount from the former price when the news is bad and pessimism is rampant. Thus, as I wrote in *On the Couch*, every once in a while, the market needs a trip to the shrink.
It’s important to note that, as my partner John Frank points out, in comparison to the total number who own each company, it takes relatively few people to drive prices up during bubbles or down during crashes.
When shares in a company that was worth $10 billion a month ago trade at prices implying a valuation of $12 billion or $8 billion, it doesn’t mean the whole company would change hands at these prices; just a tiny sliver. Regardless, a few emotional investors can move prices much more than should be the case.
The worst thing you can do is join in when other investors go off on these irrational jags. It’s far better to watch with bemusement from the sidelines, buttressed by an understanding of how markets work.
But better still to see Mr. Market’s overreactions for what they are and accommodate him, selling to him when he’s eager to buy regardless of how high the price is, and buying from him when he desperately wants out. Here’s how Ben Graham followed the introduction of Mr. Market that I included on page 1:
If you are a prudent investor or a sensible businessman will you let Mr. Market’s daily communication determine your view of the value of your $1,000 interest in the enterprise?
Only in case you agree with him, or in case you want to trade with him. You may be happy to sell out to him when he quotes you a ridiculously high price, and equally happy to buy from him when his price is low. But the rest of the time you will be wiser to form your own ideas of the value of your holdings, based on full reports from the company about its operations and financial position.
In other words, it’s the primary job of the investor to take note when prices stray from intrinsic value and figure out how to act in response. Emotion? No. Analysis? Yes.
You can read the entire memo here:
Howard Marks Memo – Mr. Market Miscalculates
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