How nouns can help you

August 24, 2018

Bad news is an investor's best friend.

That seems illogical. And there are qualifiers: it's your best friend if you are continuing to invest. If you are not adding to positions, but only drawing down your investments, this doesn't hold. And bad news can go to worse news in individual stock positions, and unlike index funds, they can go to zero.  But let's assume for the sake of this email that you are continuing to purchase stocks and bonds. And let's assume you are doing so in broadly diversified, low-cost indexes.

As an investor, you are trying to buy future cash flows (earnings + dividends) at lower prices. The low prices come in the form of stock or index quotes, or what people commonly view as the market. People, at least of the genus Homo Sapiens, tend to get happy when markets rise and sad when they fall. They shouldn't. Rising markets just means you pay more today for the same cash flow later.

What your mathematical heart desires is falling prices and rising cash flows, where cash flows are dividends. But how, as an investor, do you buy securities on the cheap?

This is where nouns come in. I want to mention that I'm an equal opportunity linguist, and verbs and adjectives play into this as well.

Last week provided a good example. Here is a screenshot from the front page of Marketwatch.com.

I know you're looking at that Tupperware container and trying to figure out if those are frozen peppers or some type of candy. That's not the point (but for the record, I think they're peppers.) Just in this one screen, we have the words: "hit," "turmoil," "struggle," "woes," "crisis," "shock waves," "selloff," and "carnage."

Words matter. Words comprise stories, and people respond, remember, and react to stories more strongly than numbers. If a negative story emerges, it tends to get attention. In the case of these negative stories, here is what happened to the Vanguard emerging markets index fund last week (down 5.2% in a week):

This was an event triggered by Turkey, affecting the prices people were willing to pay for worldwide emerging markets. And how much of that index does Turkey represent? 0.8% (yes, zero-point-eight percent). It's the fear of contagion that drives investors to sell.

The words create the stories. The stories build the fear. The fear lowers the price. And a good investor considers buying.

Dan Cunningham

Image sources: Marketwatch.com 8/13/16, Vanguard emerging markets index 8/9/18 - 8/16/18