People have sought magical methods of stock picking as long as stocks have been traded. There will always be demand for “black box” programs that spit out stock buys and sells based on trading patterns, despite no evidence a reliable system exists. After all, if such a program did exist, wouldn’t everybody be using it?
Well, history has shown that one methodology does work — invest in quality stocks selling at good prices for the long term. Yet as we’ve seen repeatedly, investors are lured to sketchier, shorter-term strategies, especially when the market’s bubbling along. A recent article in The Wall Street Journal, for example, describes the return of Main Street investors to day-trading. One 31-year-old quoted in the article even says he’s considering quitting his job to trade full time. This type of behavior is right out of 1999, and we all know what happened then.
But we really should thank short-term investors for their service. If everyone sought quality stocks selling at reasonable prices, the advantages of doing so would eventually go away — the opportunities we see, especially in bear markets, wouldn’t exist.
John Alberg and Michael Seckler, managers and founders of Euclidean Technologies Management, discuss the reasons this successful methodology will continue to be relevant in their Advisor Perspectives article “Why Are There Timeless Lessons That Do Not Get Arbitraged Away?” The short version: because we’re human.
“We have witnessed investors collectively and repeatedly focusing on developments other than companies’ operating results,” the authors say. “When investors do this, companies’ share prices and intrinsic values can materially diverge, creating opportunities to profit when price and value eventually reconvene.”
Alberg and Seckler go on to describe human behaviors preventing us from being successful investors, including recency bias and our wiring to make fast decisions, follow the herd and feel more pain from losses than well-being from wins. “As investors search for a signal in the noise that surrounds the stock market, they overreact and attribute too much meaning to information that proves to have little to do with the long-term value of their investments,” they say. “This frenetic response to current developments causes prices to fluctuate wildly around a company’s fundamental value.”
Don’t count on this changing any time soon. “Technology innovation will surprise us, industry structures will change and regulations will evolve,” the authors say, “but the basic elements of what it means to be human will not go away.”