Imagine that you own a small business, along with one partner, Mr Market. Your working relationship is unusual, to say the least. Every day, Mr Market walks in and tells you how much he thinks your share of the firm is worth. He then gives you a chance to buy more of the business, or to sell some of your shares. You can choose to buy, sell, or do nothing. Once you give him an answer, Mr Market clocks off for the day.
There are other odd things about Mr Market. First, he’s a creature of habit. He doesn’t care what you do – buy, sell or do nothing, and he’ll still come back tomorrow, name a price and ask the same question. Second, he has little knowledge of how your shared business works (which is not surprising, given how little time he spends there). He pays attention to the details, maybe, once a year, at your small shareholders meeting – his daily quote for the value of your company is based mostly on how he feels when he walks through the door.
Third, and most importantly, how he feels changes a lot. Mr Market is emotionally unstable. He can go from elation to despair in a week, based on as little as reading the wrong headline at breakfast. His feelings towards the business and his valuation quotes can vary wildly.
As the person who runs the business, you have a far better idea than him of how it is going. This can give you some opportunities. Occasionally, Mr Market can get so down in the dumps that his offer looks tempting enough for you to increase your stake. At other times, he is so full of beans that he makes you an offer you can’t refuse, and you might offload some of your shares in the company. Most of the time, though, you ignore him.
"Mr Market is the best analogy in finance. He was born in 1949, and seventy years on, we think he is aging rather well"
Investing for the long term
This would be a strange way to run a business, but it’s exactly how long-term investors should operate when thinking about their portfolios. Mr Market doesn’t care about portfolio construction, or time horizon, or risk. His quoted price is simply the end-product of millions of transactions by various buyers and sellers – all of whom have different motivations.
The information content of a daily change in market price is almost always zero in relation to the long-term value of a company. Mr Market is just there to tell you his latest prices – the main knowledge you take away is whether he is feeling miserable or euphoric that day.
Mr Market gets the value of your business right in the long run, on average, but there can be big ups and downs in between. If he makes an especially high bid or low offer and you know your business well, then you may want to do a deal with him. But on your terms, not his.
Mr Market is the best analogy in finance. He was born in 1949, in Chapter 8 of The Intelligent Investor by the great value investor, Benjamin Graham. Seventy years on, we think Mr Market is aging rather well.
Over the last year or so we’ve talked a lot about the Lizard in all of us. It’s our analogy of how to think about the impact that emotions can have on people in their day-to-day lives, and in their investments. Mr Market scales this idea up to a global level, as a way to think about the ebb and flow of markets and how it affects our investments.
Still strong at seventy
Things have changed a lot since Ben Graham’s day. Ms Market has far more headlines to digest. She uses computers. And she’s constantly shouting quotes at us, rather than providing them once a day. She’s still not doing any real work, though – she isn’t necessarily any more knowledgeable about the actual business than Mr Market was.
The modern financial world often pretends that Ms Market knows everything. We hear a great deal about efficient markets – where the current price reflects all available information on a stock, and any repricing to update prices to reflect new information happens almost instantly.
The implicit assumption is that any move in stock prices is related to a change in business fundamentals. Much of the time, though, that isn’t the case.
Consider Apple, or Coca Cola, or GlaxoSmithKline. Their underlying businesses are incredibly stable but their share prices move every day. Why? Perhaps there’s an oversupply of shares as a big shareholder raises money to buy a new yacht. Or a lack of demand due to a public holiday in Japan. Or a wrong trade entered by a fat-fingered junior at an investment bank. It could be due to any of a million things, few of which have anything to do with iPhones, fizzy drinks or new drugs.
A real example: in September 2018, the financial world reclassified Alphabet (Google) and Facebook from the ’technology’ sector to the ‘communications services’ sector overnight. Technology index funds had to sell those shares (and buy others) immediately – pushing their prices down. Nothing happened to their underlying businesses. But their prices fell, all the same.
Ms Market doesn’t give you that context. She will never give you any context – just a price. It’s up to us as investors to be confident in our views of our portfolios. That way we can spend most of our time ignoring Ms Market, but take advantage of her pricing when we think she gets it wrong.