Meet The Crazy Mr. Market

The Crazy Mr Market

The past few weeks may have introduced some of you to Mr Market – the gentleman who just can’t decide what your business is worth. One day, he offers to pay you $1 for your share of a business. The next day, $2. After that, it could be fifty cents.

The business may not have changed, but Mr Market doesn’t really care. He makes offers based on gut feelings, panic, euphoria, greed, fear, and basically whatever floats his boat that particular day.

Mr Market was first introduced by Ben Graham in The Intelligent Investor, and he’s still as relevant today as he was in 1949 when the book was first written.

In fact, you may have seen him around the past week or two.

Today I’ll introduce you to him, talk about why this matters even for indexers, and we’ll get back to some investing basics.

Who Is Mr Market?

The volatility of the stock market the past few weeks made me pull out my copy of The Intelligent Investor, to refresh myself on the story of Mr Market. Note – that’s affiliate link in case you would like to buy the book, but I’d suggest trying the library first. It’s been out a long time.

The Intelligent Investor
This is my version of the book, from 2006.

Mr Market was invented by Ben Graham to help us visualize how the stock market operates. The story begins on Page 204 of my version of the book, in Chapter 8:

“Imagine that in some private business you own a small share that cost you $1,000. One of your partners, named Mr Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional share on that basis.

Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly…

…Basically, price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.

At other times he will do better if he forgets about the stock market and pays attention to his dividend returns and to the operating results of his companies.”

An Example From The Dot-Bomb

New York Stock Exchange

In my edition of the book, there’s commentary after each chapter by Jason Zweig from the Wall Street Journal. For Chapter Eight, he goes more in-depth into the Mr Market allegory and how his fickle nature played out in the pre-2000 dot-com bubble.

To illustrate what happened, he looks at a company called Inktomi Corp – a company valued at $25 billion on March 17, 2000 without ever making a dime in profits. The stock went up 1,900% from its IPO to hit a high of $231.63 on that day.

Two and a half years later it collapsed to a mere 25 cents. The company had gone from being valued at $25 billion to less than $40 million.

What changed about the companies business between March 2000 and September 2002? Not much. In fact they were making more money than ever. But Mr Market had decided the company was no longer worth 250 times revenue, and instead was only worth 0.35 times revenue.

Neither offer was truly reflective of the value of the company. One was overly optimistic, as were many valuations at the time. The other was overly pessimistic, reflecting the general investing mood in 2002 during the bust. Only the general feeling and mood of the market had changed over that time. People were no longer willing to give crazy valuations to tech companies, expecting revenue to grow forever. They weren’t willing to invest in unprofitable companies either.

He advises you not to let a herd of strangers control your perception of what your investments are worth. Wise advice.

Why It Matters For Indexers

What if you only invest in index funds – what do you care about the performance of individual stocks?

As an index fund owner, you can start to think that you “own the index”, and that you’re invested in VTSAX or FXAIX or something like that.

You don’t, though. Not really.

A stock index is nothing but a collection of stocks of individual companies. Each of those companies has a unique business situation.

You, via the index, own small parts of all these businesses. Mr Market still works his fickle favour, and wailing despair, over those individual companies. He overvalues them in good times and undervalues them in bad.

Being an index investor helps protect you from being overly impacted by any single companies fortunes. It doesn’t protect you from the mood of the market as a whole.

Let’s Look At Today – Amazon

Lets Look At Amazon

You’ve seen Mr Market lurking around the past few weeks, becoming increasingly irrational with his offers. He’s shouting price changes that make no sense based on the companies future. Fear and greed are ruling his proclamations.

Let’s take a close look at Amazon to illustrate this.

On September 4th, Amazon stock traded at a high of $2,039.41.

On December 24th, it traded at $1,343.96. A 31% decline in just under three months.

Did Amazon’s business suddenly decline by 31%? No.

Did they see a slowdown in sales for the 2018 holiday season? No. In fact, they had a record-breaking holiday season, with tens of millions of new Prime members. Heck, Amazon showed up at my house rather often, as we did holiday shopping from the comfort of our smartphones.

Was there a big scandal of some kind, or terrible news jepordizing the future of the company? Nothing out of the ordinary that I saw.

So what made Mr Market offer over $2,000 for a piece of Amazon’s business in September, when he was only willing to pay you just over $1,300 for that same piece on Christmas Eve?

It’s simple – the mood of the market shifted. People who were willing to previously pay a high premium for the potential for future growth weren’t willing to pay quite as much. Concerns of a potential recession in the future jeopordize companies that sell “optional” products. In a recession, people re-focus on buying necessities rather than luxuries.

Does this mean Amazon was overvalued before? Is undervalued now? Will it go up or down from this point as we move into 2019?

I don’t know, I’m not an expert who’s studied Amazon’s business model and future prospects closely. That’s why I invest in index funds.

I do know that Mr Market will continue to assign sometimes rational, and sometimes not, values to companies. People who pay attention and do that in-depth analysis can find buying opportunities when fear rules the day.

Get Back To Basics

Time to get back to basics

A crazy market is the perfect time to check and see if you have your financial basics under control.

Do you have an investment policy statement? If not, put it on your New Years goal list. You’ll find it helps you stay rational when irrational happiness– or depression – strikes. I’ve even created a free template you can use.

What are you saving and investing for? Are you clear on your goals and dreams?

You need to know where you’re going in order to craft the right savings and investment strategy to reach them. Remember, the goal here isn’t to make the most money ever, or to make a higher rate of return than your neighbors. It’s to have enough for your personal goals, dreams, and for what you want out of life.

If you check your accounts too often, and market gyrations stress you out, try going full-on ostrich. Go live your life for a while and forget about the market.

I also wrote before with ten tips for a down market, which may be helpful for you if the market keeps going crazy.

And please, please, please, DO NOT INVEST MONEY YOU NEED IN THE SHORT TERM. I saw a poor person in a Facebook group who had invested their home down payment they need in a few months invested. They lost over 20% of their money.

This applies to all kinds of goals – college savings for kids in high school, emergency funds, money to start a business, and so on. You need to evaluate not just your appetite for risk, but also your capacity (or ability to take on) risk.

The market can go down, or stay flat, for years. Markets can’t climb forever. And as John Keyes once said, “the markets can stay irrational longer than you can stay solvent.”

Further Reading

Further Reading

For more about historical bull and bear markets, check out this cool chart.

Do you need help with an asset allocation to reach your goals? I recommend Bogleheads as a go-to resource on the basics. Here’s their investment start-up kit, please go read it.

For more about the “lost decade” and how it would have played out in real investing scenarios, check out this article. You’ll see how reinvesting dividends and dollar cost averaging help you win the investing game, even when “the market” is flat.

If you think that you’ll only make perfectly rational decisions, recognize that investors are irrational. If you want proof, go check out the results of the annual Dalbar study of average investor returns vs. the overall market. You’ll be better off if you simply put your money in the market and forget about it.

2 thoughts on “Meet The Crazy Mr. Market”

  1. My first stock holding was nvdia which I bought during the dot com boom. I sold it after doubling at bought Inktomi on the way down at 15 dollars a share.

    That’s where I learned about index investing. Thankfully I was in early college so the amount was around 1k. A princely sum to a kid that age but no long term impact.

  2. Herd mentality is why there are large swing in valuations. When someone sells it can start a chain reaction and as more shares flood the market the prices drop and make a self fulfilling prophecy that the market is tanking.

    The same principle applies on the other side. I know there is a Buffet effect. If he buys a company it is almost a guarantee that it will go up as everyone wants in on the action.

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