The Value of a Sale
Did you partake in any Black Friday sales last year? The annual shopping event following Thanksgiving, named black Friday for its ability to get retailers “back into the black,” had retailers concerned in 2023. With prices rising everywhere thanks to persistent inflation, would consumers cut back on their spending?
Ultimately this fear proved unnecessary. Not only did American consumers spend, but they upped their online spending by 7.5% over last year according to data from Adobe Analytics. And some 200 million Americans took advantage of Black Friday, according to the National Retail Foundation. That’s roughly 75% of adults in this country!
This isn’t necessarily a bad thing. If consumers can get the goods and services they need at a lower price, it makes sense to buy. Sales are great ways to stock up on the things we need (and sometimes the things we want.) In every aspect of our economic lives we seek sales. Sale clothing, low prices on gasoline, even items we aren’t necessarily looking for suddenly become desirable once their advertised price drops. Conversely, we postpone purchases or actively seek alternatives when prices are increasing.
We don’t think much about this behavior because it’s inherent to our nature. When it comes to investing, however, people instinctively behave the opposite way: flocking toward markets, sectors or funds with the greatest recent price increases. There’s a reason the phrase “buy high, sell low” stays in the lexicon of investors everywhere.
Why do we want lower prices for everything we purchase except stocks? Why does human nature seemingly have this one backwards?
Apart from the usual suspects like the fear of missing out and the greater fool theory (the assumption that someone will later buy the stock at an even higher price, even though it’s overpriced) )—I believe this pattern is driven by people’s tendency to misunderstand the value of an investment.
The price-quality heuristic is an economic principle that attempts to connect the price of a product to its value. In short, consumers tend to create a mental shortcut in which they falsely assume that if something is expensive, it must be good. For example, the electronics store has two TVs side by side, one $500 and the other $1,500. We automatically assume the $1,500 TV must be better. Why else would it be three times the cost?
Unlike the TV store, stocks don’t have fixed prices or sale tags. That leaves investors in a tricky spot. Determining if they’re getting a good deal on any given stock is suddenly far more difficult than simply defaulting to the price-quality heuristic.
When investors are presented with the difficult choice of reading, researching, understanding, and following companies to roughly determine their underlying value, they instead take the path of least resistance: “XYZ Corp went up 15% last quarter, they must be doing something right. I’m going to invest my money there.” Conversely, if ABC Corp drops 10% in a month: “They must have messed something up. Sell! Sell!”
These two mental shortcuts, the value of a sale and the assumption that expensive goods are better quality, are at odds with one another. Consider this example: the $1,500 TV from earlier is now on sale for $1,000. That’s a great deal! We assume we’re going to get a high-quality TV at an attractive price. But what happens if we say the sale isn’t a sale, but rather a price reduction. That TV will never again sell for $1,500: Its permanent price is now $1,000. That feels different, doesn’t it? Suddenly we’re not getting a deal anymore. Instead, we start to wonder why the price was reduced. Was it not selling well? Is there something wrong with it? The $1,000 selling price is the same any way you look at it, but how we arrived at that price has a profound effect on the value we assign to it.
Stock prices are particularly sensitive to external shocks such as the COVID pandemic which caused the S&P 500 to drop by 30% in some 31 days. Investor panic was rampant, and investors bailed at the worst possible time. Emotion and human nature overrode logic and perspective. The same thing happened last year when financial forecasters predicted a recession. Investors took heed and withdrew $101B of markets funds, mostly in the first 3 quarters of the year. Meanwhile the S&P 500 increased 21%. The forecasters were wrong. Investors who listened to them paid the price.
The S&P 500 is composed of 503 of the largest, most profitable, and most innovative companies headquartered in the United States. You’re probably familiar with many of those companies and regularly purchase their products, regardless of swings in the stock price. My experience suggests that short-term price movements are often driven by the ebb and flow of investor sentiment in these companies, rather than the intrinsic value of successful business.
This is the value of an investment advisor. We don’t aim to forecast the economy or the markets, things which no one can consistently do well. Our goal is to remind you in moments of extreme market stress to focus on the enduring value of great companies, not random market price fluctuations.
It is crucial to approach investment decisions with more effort than choosing a TV. As the late Charlie Munger said, “The first rule of compounding: Never interrupt it unnecessarily.”