The stock market was down sharply for the second time this week. In both cases the primary reason was a knee-jerk reaction to declines in the Chinese stock market. It is feared that this may be an indicator that their economy might be slowing down.
I think this is an overreaction. In the first place, the Chinese stock market is notoriously volatile. Do we really want to take our lead from a market in a communist dictatorship? The fear that a slowing of their economy would have a substantial on ours doesn’t make sense. Exports make up about 10% of our GDP. China accounts for about 15% of our exports. There is no way they can seriously damage our economy. However, I would be wary of companies with a substantial presence in China. They have a number of serious long term issues.
Many have long claimed that the stock market is rational. They say it is made up of millions of smart people making rational decisions. As we have seen in the tech and housing booms, rational people are capable of making totally irrational decisions. A good investor makes their decisions independent of the crowd.
This was put best by Benjamin Graham. He was a famous professor who was the mentor of Warren Buffett. He used the analogy of a business partner named Mr. Market. Every day Mr. Market would show up and offer to either sell his interest or buy out his partner at a given price. Mr. Market is a very emotional guy and his offers fluctuate wildly. The partner pays no attention to Mr. Market unless he offers to sell at a low price or buy at a high price.
Whether we are buying stocks, mutual funds or investing through 401ks, there is one important thing to remember. We are not gambling over pieces of paper. We are buying shares in companies that sell goods or services. Their true value changes far less than is indicated by Mr. Market.