INVESTMENT LESSONS

On the day that the Federal Reserve lowered its interest rate on loans to banks, which experts say is meant to calm the jittery stock market, the term “value investing” was in frequent use. Value investing – basically the idea that a company’s past performance is more important than trying to figure out what will happen in the future – could return a sense of rationality to the markets, with or without more interest rate adjustments.

Last Friday, the Federal Reserve unexpectedly cut by half a percent the interest it charges on short-term loans to banks, the so-called discount rate. This is different from the federal funds rate, the amount banks charge each other, which affects interest on car loans, mortgages and other consumer borrowing.

The message was that the central bank was prepared to step in to ensure that continued problems in the mortgage market, which are rippling through the other financial markets, don’t slow the U.S. economy.

It will take more than interest rate adjustments to change investor behavior and there is a growing chorus suggesting a return to rational analysis of and expectations for market performance.

The same day as the rate cut, the Motley Fool reprinted a column by Richard Gibbons titled “The Best Investment Strategy.” “Value doesn’t always lead to quick returns (what investment strategy does?),” he wrote. “But over the long term, it blows all other strategies away by a huge margin – and does so with less volatility, to boot. It’s no coincidence that Warren Buffett is both the best-known value investor and the world’s second-richest person.”

The New York Times’ David Leonhardt made the same observation about Mr. Buffett on the same day. He also referenced a 1934 textbook by Columbia University professors Benjamin Graham and David L. Dodd, which urged investors to look at facts – the value of a company’s assets and its past performance – instead of trying to anticipate the future. Mr. Buffett took a course from and worked for Prof. Graham before starting his own company and making billions of dollars.

The bad news, according to Mr. Leonhardt, is that if the professors’ lesson of looking at several years, even a decade’s, worth of stock price to earnings comparisons, the current market is way overvalued. That means the market is still riding the bubble of the mid-1990s and that further drops are likely.

The conclusions aren’t necessarily reassuring, but the reminder that the past is the best guide to the future is timely.