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Thursday, April 21, 2016

Pockets of Market Inefficiency



Pockets of Market Inefficiency

I’ve talked about the wager value of the small and mid cap sectors of the stock market but these market inefficiencies are more structural and part of the investing landscape. There also exist pockets of inefficiencies that are more transient and temporary in nature.

When stocks are plunging and market conditions appear obviously bleak and fear holds sway over all of the market participants it can be a good time to go shopping for value. Chances are what you buy will continue to go down but rest assured you will get a good fill and you will see that price again back on the way up. Just try to pay less for a stock than what you feel it is worth. They will be out there. During a market plunge there will often be levered investors facing margin calls who will be forced to sell out their holdings. This will have nothing to do with what their investments are worth. The stocks they sell are basically on sale for anyone who has the capital and confidence to take advantage of the situation. Quite frequently after the plunge has run its course the markets will be sold out (everyone who could sell has already sold). So all the money that was in the market is now on the sidelines. If the market fails to go down anymore while the news remains bad chances are the worst is over. At this time the tiniest bit of buying will lift the markets up. When the markets recover as they always do, there will be a great influx of money back into the mutual funds who in turn will be forced to put it to use (back in the market). Prices often surge upwards because of this. Not a very efficient market is it?

When the time horizon of your anticipated change in value extends out beyond a year or so, you can copper the short term tendencies of the other market participants. In other words while they are focusing on the next quarter, you can be investing in companies that are growing their businesses for the long term (high ROE and ROIC).

Finally when the markets fall into the trap of unanimous opinion, its time to fade the market and do the opposite (like George Castanza in my favorite Seinfeld episode). This situation often describes market tops that are slowly distributing their shares out to the unwitting public. See my posts on the Current Market Environment and the Hidden message in the Stock Market.

One more thing to bear in mind. Justin Mamis wrote about this years ago. In a bear market or a bad correction, the future market leaders will often bottom first. Now I'm not sure this is true or not as I've never conducted any research into this idea but its something to bear in mind. And if you see any stocks that are going sideways while everything else is going down well that's a message in itself. relative strength works. In the long term I think the markets get it right but in the short term pockets of inefficiency exist for the astute investor to take advantage of.



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