There are many important things about the stock market that can change, such as the behaviour of market participants and their level of collective knowledge. I believe an interesting example of this can be seen in the 2008/09 financial crisis.
The period was an economic calamity and stock prices fell sharply. During the crisis, the S&P 500, a broad index for US stocks, fell by nearly 57% from peak to trough. But then-Federal Reserve chair Ben Bernanke prevented an even worse disaster from happening.
Bernanke was a scholar on the Great Depression that happened in the 1930s. In a wonderful 2002 speech for the birthday gala of celebrated economist Milton Friedman, Bernanke laid out the mistakes the US government had made during the Great Depression. He ended the speech saying (emphasis is mine):
“I would like to say to Milton and Anna: Regarding the Great Depression. You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.”
When the 2008/09 financial crisis erupted, Bernanke sought to prevent the same mistakes from happening. He largely succeeded and I think it’s telling that an 85% fall in stock prices – something that happened in the Great Depression – did not occur during the financial crisis.
I think that this trait about the market – that market participants can learn, collectively – has important implications for investors. Amazon’s (NASDAQ: AMZN) founder Jeff Bezos once said (emphasis is mine):
“I very frequently get the question: “What’s going to change in the next 10 years?” And that is a very interesting question; it’s a very common one. I almost never get the question: “What’s not going to change in the next 10 years?” And I submit to you that that second question is actually the more important of the two — because you can build a business strategy around the things that are stable in time. … [I]n our retail business, we know that customers want low prices, and I know that’s going to be true 10 years from now. They want fast delivery; they want vast selection.”
I believe this applies to investing too. It’s better to build an investment strategy in the stock market around the things that are stable in time. What is one such thing? From my observations, I think one thing about the stock market that has been stable over the long arc of history is that it has remained a place to buy and sell pieces of a business. And I think this trait about the stock market will very likely continue to be stable over time.
With this in mind, what logically follows is that a stock’s price over the long run will continue to depend on the performance of its underlying business over the same period. In turn, a stock’s price will eventually do well if its underlying business does well too. All these mean that a lasting investment strategy is to identify businesses that are able to grow well over a long period of time.
Note: An earlier version of this article was published at The Good Investors, a personal blog run by our friends.
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Disclosure: Ser Jing owns shares of Amazon.
