There has been a lot of volatility in markets in the last week and a half. One paper's headline read 'Superannuation wipe-out. Plunging world markets slash billions from mum-and-day retirement savings'.

Naturally, people are unnerved by what is going on. The ASX went down 5.5% over a two day period. It recovered slightly and has been drifting down again but more moderately. Then there is Japan. The Japanese market isn’t normally a focus, but on Monday August 5th the Nikkei went down 12.40%. This followed a fall of 5.8% on Friday. It was just last month that the Nikkei hit a record high. The index is down 25% since.

This episode takes a step back from sensationalist headlines and all the commentary we are hearing. It goes back to a concept coined by Ben Graham - Mr. Market. Mr Market was Graham’s personification of the investors. In particular, we focus in on one quote about Mr Market from Charles Ellis who founded Greenwich Associates:

“Ben Graham and Warren Buffett have talked about a charming, seductive manic-depressive gentleman named Mr. Market. Every day he shows up on your doorstep offering to do business with you, When he's manic, he'll offer to buy your stocks or sell you his for absurdly inflated prices. When he's depressed, his prices go ridiculously low. The mistake most people make is answering the door just because Mr. Market knocks. You don't have to let him in. Why should you buy just because he's excited? Why should you sell just because he's down in the dumps? A long-term investor shouldn't care about market prices.”

We talk about how this quote applies to recent market events, and how investors should react to these types of market movements.

Mark has also written an article about what has happened in markets here.

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You can find the transcript for the episode below:

Shani Jayamanne: Welcome to another episode of Investing Compass. Before we begin, a quick note that the information contained in this podcast is general in nature. It does not take into consideration your personal situations, circumstances or needs.

Mark Lamonica: All right. So I think this is the last time we're going to do this, the last plug…

Jayamanne: For the survey.

Lamonica: For the survey. And thank you very much for everyone who has filled out the survey. And remember, there is still time to do it. And on the 15th, we will be picking a random name.

Jayamanne: Will, will be picking a random name.

Lamonica: Will, will be picking a random name.

Jayamanne: So, if you have any issues, take it up with him.

Lamonica: Exactly. And that person will win a gift card. And I forgot the amount, Shani. It's $2 million. How much is the gift card for?

Jayamanne: A$250.

Lamonica: Okay. Close.

Jayamanne: Yes.

Lamonica: But anyway, we really appreciate all the responses. And we do like reading them. And Shani tells me every time a new one comes in, she won't let me see any of them because we have a very cheap SurveyMonkey plan.

Jayamanne: Yes. And I am the only one with access.

Lamonica: And she's the only one that can see it. But anyway, thank you. And we would appreciate anyone else that filled out that survey. So Shani, I got a text message.

Jayamanne: You're very popular, Mark. The only text messages I get are from Domino's.

Lamonica: Well, there you go. I send you text messages.

Jayamanne: You do, I guess.

Lamonica: But this was from my mother. And it said, and I'm quoting now, "yikes, dot, dot, dot, the stock market".

Jayamanne: A woman of few words.

Lamonica: Yeah. Which is strange because she actually is a woman of a lot of words. She writes text messages like they are emails, probably because I ignore her emails. And she puts tons of emojis.

Jayamanne: What's your favorite emoji?

Lamonica: Oh, geez, I don't know. What's that like?

Jayamanne: It's important that your mother knows this.

Lamonica: What's that frowning face that you always send me when I write you stuff on my Teams at work?

Jayamanne: I guess just a frowning face.

Lamonica: Just a frown. So I guess that's my favorite emoji because I get it so much.

Jayamanne: My favorite is the salute emoji. That's a good one. Anyway.

Lamonica: That is a good one.

Jayamanne: How did you reply to your mother?

Lamonica: Well, I didn't. But the point of the story, there is a point is not to highlight how bad of a son I am, but the point is that a lot of people have been talking about the stock market, including my mother.

Jayamanne: Yes. And, when the share market starts getting covered by the non-financial media, something big is happening.

Lamonica: Yeah, which is frustrating, I think, the way that it's portrayed because the headlines are just overly dramatic. And I actually had a reader that sent something from his local paper, and this is the headline, superannuation wipeout plunging world markets slash billions from mom and dad retirement savings.

Jayamanne: Really burying the lead here.

Lamonica: Yeah, exactly. I know, just coming out and saying what they're going to say. But yeah, it's overly dramatic. I guess to use the same phrase I used before. And I know a lot of people that are probably listening to this are unnerved by what's going on. And so we're going to do one of our periodic looks at the market. So it's been a wild week and a half. So maybe, Shani, why don't we start with what's happened?

Jayamanne: All right. So we're going to talk about three markets. We're going to talk about the U.S. because that is where this mess happened. We're going to talk about Japan because things have been crazy there. And of course, we're going to talk about Australia.

Lamonica: Okay, I'll handle the U.S. And when Shani said where this mess happened, the U.S...

Jayamanne: I meant you.

Lamonica: …she looked at me, just so everyone is aware. But just to let people know, we are recording this on August 8th. And we just want to say that because things change very quickly. So by the time this gets released on Sunday, and it's Thursday now.

Jayamanne: It'll be 25% up and…

Lamonica: …yeah, or 50% down, who knows. But let's go back and look at the U.S. So over the past month or so, we've seen pullbacks in a lot of the large tech companies. So all those household names that have driven the market high over the last few years. And we also had a jobs report in the U.S. And that came out on Friday, August 2nd. And we'll talk about both those things in more detail. But it was that jobs report that really caused the market to plunge and set off this whole thing.

Jayamanne: And this whole thing is the losses spreading globally. The ASX went down 5.5% over a two-day period, recovered slightly and has been drifting down again, but more moderately. And there's Japan. And the Japanese market isn't something we normally talk about a lot. But on Monday, August 5th, the Nikkei went down 12.4%. This followed a fall of 5.8% on Friday. It was just last month that the Nikkei hit a record high. The index is down 25% since.

Lamonica: Yeah. So that's setting the scene. And I bet if you've been following markets, you probably feel the urge to do something. And this is, of course, natural. We humans have an action bias, which we've talked about before on here, which just means that when we're confronted by something scary, we go into that fight or flight mode. And we've been presented with something scary as those media headlines that I read have painted a really ugly picture. And doing something, by the way, isn't just selling and going to cash, although that is one thing that people tend to do. But that action could be anything that is not part of your investment strategy. It could be investing more. It could be selling certain investments and buying others. So just something to think about with action.

Jayamanne: So today, we're going to take a step back from these sensationalist headlines and all the commentary we're hearing. And we're going to go back to Mark's mate, Ben Graham.

Lamonica: Yes. Ben Graham, not my literal mate, by the way, Shani.

Jayamanne: I mean, maybe.

Lamonica: You know, Ben Graham was born in 1894.

Jayamanne: Why do you know that?

Lamonica: I just know things. But 1894 means that he is 99 years older than you. And I'm not that old.

Jayamanne: Okay. Well, we're going to talk about a concept that Ben Graham came up with, and that is Mr. Market. Now, Mr. Market was Graham's personification of investors. And a lot of famous investors have talked about Mr. Market, but we want to discuss one specific quote today. And that's because Mark always makes me read the quotes. And I'm going to have him do it today. So over to you.

Lamonica: Yeah, I'd be happy to. So this quote is from a guy named Charles Ellis. And he founded a company called Greenwich Associates, which is a firm that advises institutional investors. And a little known fact, Shani, about Greenwich Associates is that I applied for a job there, and they rejected me. So there we go. So we know that they have standards. And that will add some credibility to this quote. But anyway, let's get to the quote. So Ellis says, Ben Graham and Warren Buffett have talked about a charming, seductive, manic depressive gentleman named Mr. Market. Every day he shows up on your doorstep, offering to do business with you. When he's manic, he'll offer to buy your stocks or sell you his for absurdly inflated prices. When he's depressed, his prices go ridiculously low. The mistake most people make is answering the door just because Mr. Market knocks. You don't have to let him in. Why should you buy just because he's excited? Why should you sell just because he's down in the dumps? A long-term investor should care about market prices.

Jayamanne: And we're going to focus on two words here, manic depressive. There is a reason that Ellis describes Mr. Market as manic depressive. He's diagnosing the market with a disease that involves intense mood swings. And that's what we've been seeing in the last couple of days. I want to be clear that in no way do I think this depressive state of Mr. Market has made share prices go ridiculously low. Maybe that'll come, but maybe it won't. My point is that the dramatic actions of the last few days are the result of a mood swing that can't be justified by actions alone.

Lamonica: Yeah. And so let's dig into things a little bit. And we'll dig into those things we mentioned that apparently have set the market off. So the first is a worry about how AI will be commercialized. And this is a big shift in sentiment on AI. And the trigger for this shift has been investor fears that tech companies are spending too much money on AI and that the opportunity to commercialize these investments will take longer than thought.

Jayamanne: And this probably isn't surprising, but the tech companies are spending a lot on AI. CEO Mark Zuckerberg originally said that Meta would spend $30 billion on AI-related tech infrastructure in 2024. During the first quarter earnings, he announced that they would spend $35 billion. Last week, he said it would be at least $37 billion and that the company would spend even more next year.

Lamonica: Yeah, which is a crazy amount of money. But Alphabet, so Google's parent company, of course, does not want to be outspent. So in the last quarter, which they reported in their results, they spent $145 million per day on AI infrastructure. And that's a lot of spending. And I do think investors should be concerned. The spending also seems to be accelerating, as we saw with the Meta series of announcements. And this, of course, can happen if a company sees a great opportunity. It can also happen if a company sees a mortal threat. And I think in the case of Meta and Alphabet, it's the latter. So they both have basically monopolies of social media and search, respectively. Neither of them charges for these basic services, and they just use them to sell advertising. So AI is a huge threat, because if you are the best, like Alphabet is, like Google is, at searching the internet for the right answer that, of course, is less valuable when AI will just tell you the answer. And the ability to generate that addictive feed that gets people scrolling through their phones for hours, that's less valuable if AI can personalize and personally curate content for each person. So both companies need AI to defend their turf.

Jayamanne: And the question we have to ask ourselves is if the market is rationally assessing these concerns, which has sent Meta shares down close to 12% in the past month, and Alphabet shares down close to 15%. I would say no. None of this information is new. The business model for Meta and Alphabet hasn't changed. Spending was high, and it's still high.

Lamonica: And if the concern was tech companies overspending, it would make sense for the beneficiaries of that spending to be flying high. And that is, of course, the AI poster child, NVIDIA. Or how am I supposed to pronounce it, Shani? We did that after.

Jayamanne: NVIDIA.

Lamonica: NVIDIA. Anyway.

Jayamanne: You can pronounce it however you like.

Lamonica: Thank you. NVIDIA ask Shani to say sponge sometime, and you're in for a wild ride. But most of that spending, as we said, is on these new data centers. So that's that AI infrastructure because AI requires a lot of computing power. And the more AI computing power used, the more chips are needed, of course, to support it. But despite all of this spending, and apparently investors being worried that tech companies are spending too much, NVIDIA shares are down 20% over the last month. And it's hard to find a rational explanation for these dramatic market moves. So I think the indication is that Mr. Market's mania over AI has turned into a depressive episode. And that, of course, makes it very difficult to predict where things are going to go.

Jayamanne: All right. So let's turn our attention to the U.S. Mark mentioned the jobs report earlier. It showed that in June, fewer new jobs were added, and the unemployment rate rose to 4.3%. This set off the plunge in the U.S. at the end of the last week, which has carried into trading on Monday. Investors are worried that the U.S. is headed to a recession.

Lamonica: And here's the funny thing, Shani, that literally until Friday, stock investors had taken any news of a softer economy as proof that there would be room for the Federal Reserve to cut interest rates. And we've seen the same thing in Australia with the Reserve Bank. And this is strange, but it's been happening for a couple years. The market has just been so fixated on rate cuts that bad economic news was cheered on by the market because the assumption was that that would mean lower interest rates.

Jayamanne: And now apparently bad news is bad news. Chief U.S. economist at Morningstar is Preston Caldwell. He explored the jobs report and cited the Sahm Rule as one of the reasons the U.S. market is spooked. And this is the first time either of us had ever heard about the Sahm Rule, but we did some research. It was named after a former Federal Reserve economist named Claudia Sahm in 2019.

Lamonica: And this whole thing with the Sahm Rule may be the dumbest thing ever.

Jayamanne: All right, cue up the music, Will.

Lamonica: Anyway, the press is, of course, like breathlessly reporting that the Sahm Rule has never been wrong, which is a pretty generous interpretation of the fact. So the Sahm Rule was cited in a paper that she wrote, arguing that government stimulus should be applied at signs of a recession. She deliberately searched, and this paper was written in 2019, by the way. So she deliberately searched for an indicator that proved or that went off in all of the previous recessions. So it was designed to explain every previous recession by backtesting different variations of a rule until she found one that worked. So describing it as never being wrong is a bit of a stretch. And we can actually go, we looked up what Sahm, what she has to say about her rule. She said, the Sahm Rule is an empirical regularity. It's not a proposition. It's not a law of nature. I created the Sahm Rule to send out stimulus checks automatically. The idea was to act fast, to make the recession less severe, and help families. The star was always the stimulus checks, not the indicator that other people named after me.

Jayamanne: The Sahm Rule just seems to be a bit of drama inserted into the situation to drive Mr. Market into a depressive state. The U.S. economy does look to be slowing. Then again, the Federal Reserve has been trying to slow the economy to control inflation. And it looks like there is a lot of good news on the inflation front and interest rates may come down. On balance, things look pretty good economically.

Lamonica: Yeah. And once again, I just can't help but think that after years of having interest rate cuts as a holy grail for the market, it's strange how quickly things have changed. Strong economic ratings used to make the market go down. Poor ratings made it go up. This seems to be another indication that Mr. Market has simply switched from a manic to a depressive phase. When Mr. Market is depressed, he finds reasons to be depressed and ignores the good things going on. And that seems to be what's happening with Mr. Market. And I'd say probably with me as well.

Jayamanne: Lots of red flags for Mr. Market and for Mark. But we think both of these reasons for the markets falling are not cases of the facts changing, but simply moods changing. Of course, that doesn't change the fact that many investors are nervous. And the question is if investors should do anything after the last couple of days, are we entering a bear market?

Lamonica: And of course, the answer is nobody knows. Most of the people we see quoted in the press about what the market will do next are wrong. And I can say that because they are always mostly wrong. It's just too hard to predict the future over the short term to make most pronouncements anything more than a guess.

Jayamanne: Imagine a scenario where an investor made changes to their portfolio based on changing consensus view of economic conditions. There would have been a lot of changes over the past couple of years. It's hard to remember each time the consensus are bad interest rates have changed. It's hard to remember each market reaction. It was all just noise.

Lamonica: And we do need to remember that what has happened is not unique. So despite all those ridiculous headlines, we need to remember 2022 the S&P 500 corrected four times. And that's a drop of 10% or more. In 2023, there was one market correction. Since 1980, the S&P 500 has dropped 5% to 10% 4.5 times a year. It happened 12 times in 2022 and three times in 2023.

Jayamanne: And we are trying to minimize how some listeners are feeling right now. It is natural. We're just trying to provide some context, and this happens all the time. The explanations in the media just don't hold up to scrutiny and market sentiment can switch quickly.

Lamonica: The fact that these moves are based on emotions that turn so quickly shows how unpredictable the market is right now. That unpredictability makes it foolish for an investor to try and act in anticipation of the next move. Chances are anything you do now will diminish the outcome you achieve over the long term.

Jayamanne: And there's ample research that the average investor underperforms by 1% to 1.5% a year due to emotional selling. Morningstar's former head of behavioral science, Steve Wendell, conducted a study showing those results. Researchers Friesen and Sapp estimate that emotional selling decreases investor returns by about 1.5% per year. Vanguard also places it at about 1.5% annually. Morningstar's Mind the Gap study has shown how investors have underperformed the investments that they bought and sold by up to 1.7% a year.

Lamonica: Yes. So no emotional selling.

Jayamanne: Yes.

Lamonica: More emotional eating.

Jayamanne: Yes. Binge eating.

Lamonica: Yes.

Jayamanne: I'm really good at that.

Lamonica: Yes. Shani sent me a message before we started this podcast saying I'm full of potato. You did eat some chips. But anyway, enough about your eating habits. We do need to understand that this emotional selling, of course, is very costly over the long term. So that 1.5% is huge. So that's the difference between financial independence and just scraping by. It's a difference between achieving your goal and having to compromise.

Jayamanne: Our advice is simple. If you don't have an investment strategy, now is a good time to create one. If you do have a strategy, then follow it. Control what you can control. Make sure your asset allocation remains appropriate for the returns you need to achieve your goals. Focus on saving money and investing it according to your plan.

Lamonica: Do your best to control your emotions. Guard against your action bias, creating justifications to do something. The future market moves aren't any more predictable than what has happened in the past week. You feel the urge to take action, put some effort into slowing down the decision-making process. Write down all the reasons why the move you are making is the right thing to do. And then write down all the reasons it isn't. Call up a mate, talk through what you're considering. All of this will slow things down.

Jayamanne: So I'll call Domino's. You call Ben Graham.

Lamonica: Okay. I mean, that sounds like a better deal for me because Domino's is terrible pizza.

Jayamanne: And Ben Graham's dead.

Lamonica: Wow. And on that note, we'll be ending the podcast. But thank you guys very much for listening. We do appreciate everyone who's filled out the survey. Jump in it right now. If you would like to win that $2 million gift card.

Jayamanne: Mark, we've talked about the compliance issues. You can't say that stuff.

Lamonica: The AUD250 Visa gift card. Thank you all for listening.

(Disclaimer: Any advice in this podcast is general advice or regulated financial advice under New Zealand law prepared by Morningstar Australasia Proprietary Limited and/or Morningstar Research Limited without reference to your financial objectives, situations or needs. You should consider the advice in light of these matters and any relevant product disclosure statement before making any decision to invest. To obtain advice for your own situation, contact a financial advisor.)