It seems like every day I read an article explaining why investors should either use the coronavirus crash to buy FTSE 100 stocks, or sell everything they own immediately. I think what all of these takes have in common is that they all base their conclusions on widely available data. For instance, I recently saw a piece arguing that investors should run for cover in anticipation of the latest US jobless claims data that came out last week.
It was widely believed that the figure would be the worst ever recorded, and much worse than forecast. The previous week’s number was 282,000. The consensus forecast was 1.6 million. The actual number was more than twice as big: almost 3.3 million. And what do you think happened? The market rallied almost 8%.
Be on the second level
What is the point of this story? I’m not saying that you should buy or sell stocks based on economic data that comes out (unless it results in stocks becoming exceptionally cheap). That is speculation, not investing. What I am saying is that predictions based on what everyone else knows rarely work out. You can’t invest based on what everyone else knows. You need to think about what everyone else doesn’t know. Value investor Howard Marks calls this ‘second level thinking’.
If you are trying to beat the market, then it doesn’t make sense to do the same thing that everyone else does. At that point, you might as well just buy the index. You need to think about what everyone else is going to do, and position yourself accordingly. For instance, if everyone believes that a company is going to the moon, then the stock is likely to be extremely expensive. In this case, you should do the opposite of what everyone is doing and stay away. Conversely, a company that everyone believes is destined for failure is likely to be extremely cheap.
Make sure you buy cheap
Now, this isn’t to say that you should only buy unfashionable stocks (although there are studies that demonstrate that consistently buying the cheapest percentiles of the FTSE 100 or the S&P 500 is a winning strategy), and you should certainly always do your own research. But if you try to think differently to everyone else, you can be sure that you are consistently in a position to buy cheap stocks.
Making sure that you buy cheap is one of the biggest factors in building a winning portfolio. You can’t time the market – and you should be skeptical of anyone who claims they can – but you can make sure that you deploy capital in places where it can go as far as possible. You need to look at metrics like price-to-earnings ratio and dividend yield and look for the best bargains available. If you do that, and try to be different to everyone else, you don’t need to worry about timing the market.
