Backing and Filling

It is our view that investors should not focus too much on the markets but rather on the fundamentals of the underlying companies in which they invest.

In line with that, we don't put much store in technical analysis, which is primarily focused on analysis of market moves and the short-term factors of security market supply and demand that create changes from day to day. We believe investment decisions are better made based on the fundamental analysis of a business and its business prospects.

However, we do think readers should be familiar with the concept of "backing and filling," which is what we call the market's need to pause and consolidate after a long period of broad market gains.

The general market has enjoyed almost uninterrupted gains since late August of last year, and we have been saying for some time that it is probably past due for some consolidation. It's similar to piling up loose earth into a huge mound -- at some point you have to tamp it down in order to build a more solid base.

It seems that the markets are finally using the ongoing turmoil in the Middle East as an excuse to sell off. It would not surprise us if this turns into a period of "backing and filling," and it would probably be healthy for some of that to take place. The important thing for investors to remember is to focus on the fundamentals of their investments and not to allow market-based gyrations to have an undue impact on their thinking.

Another point about the recent events in the Middle East, which can be safely described as a complete surprise in their timing and nature, is the danger of making speculative bets on the short-term movement of things such as commodity prices or the strength of US dollar. While many look at Fed policy and conclude that it will likely lead to inflation and the weakening of the dollar relative to other currencies, unexpected geopolitical turmoil typically creates demand for US Treasuries and a strengthening of the US dollar. Such a scenario caught many foreign exchange speculators who had bet against the dollar off-guard in 2008.

For more on this subject, we recommend investors revisit our 2007 whitepaper entitled "Gambling, Speculation, and Investment" as well as previously published posts such as this one and this one.

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