Walking The Dog vs Stock Market Cycle

 

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André Kostolany, a renowned investor and market philosopher, used the analogy of a man walking his dog to explain the relationship between the stock market and the economy. This analogy is particularly insightful for long-term value investors, as it illustrates the concepts of market volatility, reversion to the mean, and the importance of patience.

### The Analogy:

**The Man: Represents the **economy** or the intrinsic value of the market. The man walks in a steady, predictable direction, symbolizing the gradual growth of the economy over time.

**The Dog: Represents the **stock market**. The dog runs back and forth, sometimes ahead of the man, sometimes behind, and occasionally even veers off to sniff something interesting. This symbolizes the short-term volatility and irrational behavior of the stock market.

 

Key Lessons for Long-Term Value Investors:

1. Short-Term Volatility vs. Long-Term Growth:

The dog (stock market) is often erratic and unpredictable in the short term, moving ahead of or lagging behind the man (economy). This reflects how stock prices can overreact to news, emotions, or speculation, leading to bubbles or crashes.

However, over the long term, the dog always returns to the man. Similarly, the stock market tends to reflect the underlying fundamentals of the economy over time. This is the principle of **reversion to the mean**.

2. Focus on the Man, Not the Dog:

As a long-term investor, your focus should be on the man (the economy or intrinsic value) rather than the dog (short-term market movements). Trying to predict the dog's every move is futile and often leads to poor investment decisions.

Instead, concentrate on identifying companies with strong fundamentals, competitive advantages, and sustainable growth potential. These are the "men" that will continue moving forward over time.

3. Patience is Key:

The analogy emphasizes the importance of patience. The dog may wander far from the man, but it will eventually return. Similarly, the stock market may deviate significantly from its intrinsic value, but over time, it will revert to the mean.

For value investors, this means staying disciplined and not being swayed by short-term market fluctuations. If you've done your homework and invested in high-quality assets, time will reward you.

4. Market Inefficiencies Create Opportunities:

The dog's erratic behavior creates opportunities for savvy investors. When the market (dog) is far behind the economy (man), it may be a good time to buy undervalued stocks. Conversely, when the market is far ahead, it may be a sign to exercise caution or sell overvalued assets.

 This aligns with the value investing principle of buying when there's a margin of safety and selling when prices exceed intrinsic value.

5. The Economy Drives the Market in the Long Run:

 While the stock market can diverge from the economy in the short term, it is ultimately tethered to it. Economic growth, productivity, and innovation drive long-term market returns.

As a long-term investor, you should have confidence in the resilience and growth potential of the economy, even if the market experiences temporary setbacks.

Kostolany's analogy is a powerful reminder that the stock market is not the economy. While the market may fluctuate wildly in the short term, it is ultimately guided by the steady progress of the economy. For long-term value investors, this means staying focused on fundamentals, maintaining discipline, and being patient. By doing so, you can take advantage of market inefficiencies and achieve sustainable returns over time.

 

Stock Market Cycles, Mean Reversion, and Why Every Dog Has Its Day

The stock market, like nature, moves in cycles. Just as seasons change from spring to summer, autumn, and winter, different sectors and industries take turns to shine or suffer. No sector stays at the top forever, and no industry stays in the dumps permanently. This is why people say, **“Every dog has its day.”**  

As long-term investors, understanding these cycles and the principle of **mean reversion** can help us make better investment decisions. Instead of chasing the hottest stocks when they are overvalued or panicking when our holdings are temporarily down, we can use cycles to our advantage—buying when sectors are out of favor and selling when they become too expensive.  

Let’s break down these ideas and how they apply to long-term investing and portfolio management.  

**1. Stock Market Cycles: The Ups and Downs of Every Sector**  

The stock market does not move in a straight line. Different industries go through periods of boom and bust, depending on economic conditions, interest rates, government policies, and investor sentiment.  

For example, during the COVID-19 pandemic, tech stocks were on fire. Companies in cloud computing, e-commerce, and remote work solutions were seen as essential, and their stock prices skyrocketed. However, as interest rates rose and the economy reopened, these same tech stocks crashed as investors rotated into value stocks like banks, commodities, and energy companies.  

Similarly, REITs (Real Estate Investment Trusts) were highly popular when interest rates were low. Investors loved them for their high dividends. But when interest rates started rising, suddenly, everyone said REITs were bad because borrowing costs increased. Their prices dropped, even though the fundamentals of many high-quality REITs remained solid.  

Every sector experiences these ups and downs. Understanding this allows long-term investors to take advantage of **irrational market movements** instead of being victims of them.  

**2. Mean Reversion: Why Extreme Performances Don’t Last Forever**  

This brings us to the concept of **mean reversion**—the idea that stock prices, sectors, and even the overall market tend to return to their historical averages over time.  

If a stock or sector performs exceptionally well for a period, it usually corrects back down. Similarly, if a sector has been beaten down for too long, eventually, bargain hunters step in, and the sector recovers.  

Let’s look at some real-world examples:  

**Technology Stocks** – In 2020-2021, everyone was piling into high-growth tech stocks, sending valuations to sky-high levels. Companies like Zoom, Roku,Lyft,Teladoc, Peloton , DocuSign and PayPal saw their stock prices multiply, despite little change in their underlying fundamentals. Then, as interest rates rose and liquidity tightened, these stocks crashed, reverting to more reasonable valuations and some not even recover today.

**Banking and Financials** – In contrast, bank stocks were out of favor in 2019/20 during COVID-19 pandemic crisis when interest rates were low. DBS, OCBC, and UOB were all trading at attractive valuations, but nobody wanted them. Fast forward to 2022-2024, when interest rates climbed, and suddenly, banks were back in favor, making new highs. This was a clear case of mean reversion at work.  

**REITs and Dividend Stocks** – When rates were low, investors loved dividend stocks. But when rates rose, REITs got hammered, even though their underlying real estate assets remained strong. Over time, as interest rates stabilize, REITs will once again become attractive, and investors who bought at the lows will benefit.  

**Commodities and Oil Stocks** – Oil prices are highly cyclical. When demand is weak, oil prices drop, and energy stocks suffer. But when supply is tight or geopolitical events disrupt production, oil prices spike, and energy stocks rally. Investors who understand cycles buy oil stocks when prices are low and wait patiently for the next up- cycle.  

The key takeaway? **No sector stays hot forever, and no sector stays cold forever.**

 As long-term investors, we must recognize when sectors are overvalued or undervalued and position ourselves accordingly.  

 **3. How Long-Term Investors Should Treat Market Cycles and Mean Reversion**  

 

A. Don’t Chase the Trend—Buy When Sectors Are Out of Favor

One of the biggest mistakes investors make is **buying what’s hot** and ignoring what’s cheap. When everyone is talking about a sector and prices are at all-time highs, it’s usually too late to buy. On the other hand, when a sector is hated, that’s often when the best opportunities arise.  

For example, in 2019/20  nobody wanted bank stocks because of COVID-19 pandemic. That was the best time to buy.  In 2022/3, tech stocks were beaten down when FED start to increase interest rate . Investors who focused on fundamentally strong companies were able to buy them at a discount.  

Also, it seems that now everyone was afraid of REITs because of rising interest rates. But for long-term dividend investors, that might be an opportunity to accumulate high-quality REITs at attractive yields.  

Instead of chasing past performance, long-term investors should **look for sectors that are out of favor but fundamentally strong**.

  

B. Diversification with a Value Mindset  

While cycles exist, **timing them perfectly is impossible**. Instead of betting everything on one sector, long-term investors should maintain a diversified portfolio but **allocate more to undervalued sectors**, aka "portfolio re-balancing".  

For example, if you see that banks are cheap and tech stocks are expensive, you can:  

- Allocate more capital to bank stocks while reducing exposure to overpriced tech stocks.  

- Reinvest dividends from overvalued sectors into undervalued sectors.  

- Keep cash ready to deploy when a sector becomes cheap.  

By balancing your portfolio based on valuations, you avoid excessive exposure to bubbles and crashes.  

 

C. Patience and Discipline – Let Mean Reversion Work in Your Favor

The hardest part of long-term investing is **waiting**. When you buy an out-of-favor sector, it may not recover immediately. The market can remain irrational for longer than we expect. But if the fundamentals are strong, patience will be rewarded.  

A great example is Singapore banks where  During the Global Financial Crisis (2008-2009), when COVID-19 pandemic caused a market panic, DBS, OCBC, and UOB all dropped heavily. But those who held on and added during the crisis saw their investments multiply over the next decade.   Long-term investors who bought during the crash saw huge gains when the economy recovered.  

Again, as mentioned earlier,the same applies to REITs today. Many are trading at lower prices due to high interest rates. But for long-term investors focused on passive income, these price drops are opportunities to accumulate. When rates stabilize, these high-quality REITs will revert to fair value.  

Conclusion: Buy Low, Hold, and Let the Market Work for You

The stock market is always moving in cycles, and **every dog has its day**. No sector stays at the top forever, and no sector stays down forever. By understanding **mean reversion**, long-term investors can take advantage of irrational market swings.  

Mean reversion is an overlooked and underestimated "financial concept" as investors often just look at figures and other financial ratio analysis,together with understanding of "behavioral finance" , one can take advantage of market's "irrationality" and perform better in the long run.

Instead of panicking when prices drop, view downturns as opportunities to buy undervalued assets. Instead of chasing the hottest sectors, look for what’s out of favor but fundamentally strong.  

Investing is not about predicting short-term moves but about recognizing long-term value. If you buy when things look bad but are fundamentally sound, and you hold with patience, the market cycle will eventually work in your favor.  

What sectors are looking undervalued to you now? Are you taking advantage of mean reversion, or are you following the crowd?

“不管黑狗,白狗, 能帮你看家的就是好狗”

Cheers! 

STE