Most people think investing is about money. That’s obviously true, but it’s not the whole story. Another, perhaps larger part of investing is about emotions — yours and the emotions of others on Wall Street. In fact, if there’s one key takeaway from pandemic-scarred 2020, it should probably be the importance of patience.
Meet Mr. Market
Benjamin Graham, the man who helped to train Warren Buffett and is generally considered the father of financial analysis, used an interesting metaphor to describe Wall Street. Paraphrasing, he said that investing was like working with a partner named Mr. Market. Every day Mr. Market would either offer to buy your half of the business or sell you his based on the mood he was in at that given moment. Some days he was too excited and some days he was too pessimistic, presenting opportunities for you to buy and sell at desirable prices.
A devoted value investor, it makes sense that Graham would think about investing in this way. But it really is a great mental image with regard to Wall Street, which tends to shift between emotional extremes. The early 2020 bear market is a prime example, as the coronavirus pandemic quickly pushed stocks lower only to have investors switch gears and drive stocks higher again. As 2020 draws to a close with the S&P 500 up 14% or so, it’s almost hard to believe that the index was down around 30% at one point early in the year.
How rational was this seesaw year? The answer is likely to be not very rational at all when you look out over the long term. In fact, in many cases, investors would have been best off taking a deep breath and doing nothing. A willingness to sit tight and be patient paid off.
Simply put, not every situation calls for an immediate reaction. For example, industrial giant 3M (NYSE:MMM) fell sharply during the bear market and has basically recovered all of the ground it lost. Its business is cyclical, so the fact that revenue and earnings are under pressure today, during a recession, is hardly surprising. And nothing dramatically changed at the historically innovation-driven company to suggest that the stock should have fallen more than 30% during the bear market.
Buying during the depths of the downturn was probably a good call. Selling, however, would have been a mistake, given the quick recovery and the fact that nothing material changed at 3M. In this case, the key to holding tight was understanding what you own. To put some perspective on this, 3M’s debt-to-equity ratio is 0.2 or so and it covers its trailing interest expenses 14 times over. Financial risk is modest at best. Moreover, it has an over six-decade-long streak of annual dividend increases under its belt. That’s an example of the company’s commitment to dividend investors, but also shows that it has deftly managed many negative economic cycles before. Yes, the COVID-19-led downturn was a reason to worry, but it was not worth panicking about — assuming you had a good handle on 3M’s business.
But doing nothing doesn’t work in every case, with some sectors still facing material headwinds. However, for those willing to be patient, that could actually be an opportunity now that the coronavirus storm clouds are slowly starting to clear.
A “big oil” opportunity
Energy stocks have been hit particularly hard by the pandemic thanks to the shutdowns being used to slow its spread. This led to a massive decline in energy demand and, as you would expect, steep drops in the prices for oil and natural gas. The thing is, this is really just an extreme example of the supply and demand cycle that has always existed in the energy patch. If history is any guide, supply will be curtailed (drillers are indeed pulling back) and demand will eventually pick up again (vaccines will be vital on this side of the equation). The end result is likely to be a restoration of balance and higher commodity prices.
That’s not to suggest that there are no risks; highly leveraged drillers are already going bankrupt and getting acquired, helping to clear the oversupply situation. It’s probably best for investors to stick to, or even switch to, large and financially strong companies in the sector, like Chevron (NYSE:CVX). This integrated energy giant’s leverage is modest and its capital spending needs are relatively low. It should be able to muddle through this downturn in relative stride. In fact, having made its own acquisition, Chevron is likely to come out the other side of this cycle a stronger company than when it entered it.
The big takeaway
When you step back and try to learn from 2020, the lesson you should probably take to heart is to avoid being like Mr. Market. That means controlling your emotions enough to think long-term even when stocks are volatile. In short, you need to be patient. Industrial giant 3M is an example of this, since sitting pat and doing nothing was a good call for current shareholders. That said, the upheaval in the market is still presenting opportunities, which integrated oil major Chevron shows. In the end, you want to keep your cool so you can use Mr. Market’s emotional whims to your advantage.
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