Volatility remains a concern. So to appreciate why we favor companies with consistently good earnings and discourage efforts to time the market, you have to consider the often overlooked studies of Edson Gould.
Gould is regarded as one of the best market technicians of all time, albeit his enviable track record was logged during the 1960s and 1970s – before the Dow had even cracked the 1,000 level.
All the same, he’s relevant because he was the first to suggest that economic fundamentals and monetary conditions alone can’t explain (or predict) stock market behavior.
He began his exhaustive studies as an analyst for Moody’s in the 1920s, intent on building a model that could accurately predict the movement of stocks.
Gould carried indexes back as far as 100 years, incorporating everything from Newton’s laws of motion to quantum physics, and found that regardless of how much you knew about the underlying fundamentals, you still didn’t get very accurate stock market answers.
“I recognized that economic and monetary forecasts and trends were vital in projecting stock prices three and four years out, but came to the realization that they could have little value when trying to forecast stock prices over a period of weeks, several months, or even as many as two years,” said Gould.
He knew another key variable was at play – one that would fill in the blank, so to speak, and explain the market’s random behavior (over a shorter time period).
The Stock Market’s X Factor
The way Gould looked at the market forever changed when he read The Crowd by French social scientist, Gustave Le Bon, which was a study of the popular mind, based largely upon the experience of crowds in the French Revolution.
Upon reading and re-reading the book, Gould “came to the realization that the action of the stock market is nothing more nor less than a manifestation of mass crowd psychology in action.”
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And given that crowd psychology is not something that can be accurately predicted, trying to surmise the stock market’s next directional move is all but impossible.
It’s simple really. Easy money and an economy that fosters prosperity make the likelihood of an extended bull market very good.
Strained banking resources and too much debt limit the possibility of such a price advance.
Everything else – the day-to-day volatility of prices – can be attributed to the mood swings of the crowd.
Think of the stock market as an auction of sorts.
The market auctions up until there are no more buyers. Then it reverses and moves down until there are no more sellers.
All market activity occurs within such a framework. Through this lens, it’s easier to understand how psychology directly affects the manner in which the auction commences.
How to Remove Uncertainty
Owning shares of “Rembrandts” lets you remove a lot of market uncertainty. By “Rembrandts,” I simply mean sound companies with consistently strong earnings. (Yes, they still exist.)
As Alexander Green says in his book, The Gone Fishin’ Portfolio, “Over the long term, there is one thing about equities that you can safely take to the bank: Share prices follow earnings.
Look back through history and try to find even a single company that increased its earnings quarter after quarter, year after year, and the stock didn’t tag along. Conversely, try to uncover one whose earnings declined year after year and the stock continued to move up. It just doesn’t happen.”
Gould often referred to the stock market as a crowd void of reason, which simply reacts animalistically and emotionally. So keep a calm head in this market, own a few Rembrandts and don’t let the crowd lead you over a cliff.
Ahead of the tape,