Markets are meeting places where people come together (not necessarily physically) to exchange one thing (usually money) for another. Markets have a number of functions, one of which is to eliminate opportunities for excess returns. ... The bottom line is that first- level thinkers see what’s on the surface, react to it simplistically, and buy or sell on the basis of their reactions. They don’t understand their setting as a marketplace where asset prices reflect and depend on the expectations of the participants. They ignore the part that others play in how prices change. And they fail to understand the implications of all this for the route to success. ... The investor’s basic goal of buying desirable assets at fair prices is sensible and straightforward. But the deeper you look, the more you see how many aspects of successful investing are counterintuitive and how much of what seems obvious is wrong. ... The truth is, the best buys are usually found in the things most people don’t understand or believe in. These might be securities, investment approaches or investing concepts, but the fact that something isn’t widely accepted usually serves as a green light to those who’re perceptive (and contrary) enough to see it. ... Confidence is one of the key emotions, and I attribute a lot of the market’s recent volatility to a swing from too much of it a short while ago to too little more recently. The swing may have resulted from disillusionment: it’s particularly painful when investors recognize that they know far less than they had thought about how the world works.
If everyone believes it’s a bargain, how can it not have been bought up by the crowd and had its price lifted to non-bargain status as a result? You and I know the things all investors find desirable are unlikely to represent good investment opportunities. But aren’t most bubbles driven by the belief that they do? ... Logically speaking, the bargains that everyone has come to believe in can’t still be bargains . . . but that doesn’t stop people from falling in love with them nevertheless. Yogi was right in indirectly highlighting the illogicality of “common knowledge.” As long as people’s reactions to things fail to be reasonable and measured, the spoils will go to those who are able to recognize this contradiction. ... Smart fantasy football participants understand that the goal isn’t to acquire the best players, or players with the lowest absolute price tags, but players whose “salaries” understate their merit – those who are underpriced relative to their potential and might amass more points in the next game than the cost to draft them reflects. Likewise, smart investors know the goal isn’t to find the best companies, or stocks with the lowest absolute dollar prices or p/e ratios, but the ones whose potential isn’t fully reflected in their price. In both of these competitive arenas, the prize goes to those who see value others miss. ... rather than judge a decision solely on the basis of the outcome, you have to consider (a) the quality of the process that led to the decision, (b) the a priori probability that the decision would work (which is very different from the question of whether it did work), (c) the other decisions that could have been made, (d) all of the events that reasonably could have unfolded, and thus (e) which of the decisions had the highest probability of success.
This memo is my attempt to send the markets to the psychiatrist’s couch, and an exploration of what might be learned there. ... One of the most notable behavioral traits among investors is their tendency to overlook negatives or understate their significance for a while, and then eventually to capitulate and overreact to them on the downside. ... “Everyone knew” for years that the Chinese economy had been overstimulated with cheap financing, and that this had led to excessive investment in fixed assets. … One of the most significant factors keeping investors from reaching appropriate conclusions is their tendency to assess the world with emotionalism rather than objectivity. Their failings take two primary forms: selective perception and skewed interpretation. ... The bottom line is that investor psychology rarely gives equal weight to both favorable and unfavorable developments. Likewise, investors’ interpretation of events is usually biased by their emotional reaction to whatever is going on at the moment. ... in the real world, things generally fluctuate between “pretty good” and “not so hot.” But in the world of investing, perception often swings from “flawless” to “hopeless.” ... There is a general sense among my colleagues that investors have gone from evaluating securities based on the attractiveness of their yield (with company fundamentals viewed optimistically) to judging them on the basis of the likely recovery in a restructuring (with fundamentals viewed pessimistically).
Since we’re in the midst of election season, with promises of cures for our economic woes being thrown around, this seems like a particularly appropriate time to explore what can and can’t be achieved within the laws of economics. Those laws might not work 100% of the time the way physical laws do, but they generally tend to define the range of outcomes. It’s my goal here to point out how some of the things that central banks and governments try to do – and election candidates promise to do – fly in the face of those laws. ... Let’s start with central banks’ attempts to achieve monetary stimulus. When central banks want to help economies grow, they take actions such as reducing the interest rates they charge on loans to banks or, more recently, buying assets (“quantitative easing”). In theory, both of these will add to the funds in circulation and encourage economic activity. The lower rates are, and the more money there is in circulation, the more likely people and businesses will be to borrow, spend and invest. These things will make the economy more vibrant. ... But there’s a catch. Central bankers can’t create economic progress they can only stimulate activity temporarily. ... In the long term, these things are independent of the amount of money in circulation or the rate of interest. The level of economic activity is determined by the nation’s productiveness. ... Much of what central banks do consists of making things happen today that otherwise would happen sometime in the future. ... the truth is, this “tyranny of the majority” is an unhealthy development. First, society does better when able members have strong incentive to contribute. Second, upward aspiration and mobility will be constrained when taxes become confiscatory. Finally, taxpayers aren’t necessarily powerless in the face of rising tax rates.
The opinions of experts concerning the future are accorded great weight ... but they’re still just opinions. Experts may be right more often than the rest of us, but they’re unlikely to be right all the time, or anything close to it. ... A lot of people's lives would be more tranquil and more productive if they accepted that what the media says about an upcoming event - and whether you watch of not - won't have any impact on the outcome. ... Today many analysts seem preoccupied with central bank behavior, government actions, trends in interest rates and currencies, and the movement of markets, as opposed to the fortunes of individual companies. … Most people don’t want to tempt fate by saying things will go well forever, and in fact they know they won’t. It’s just that they can’t decide what it is that will go wrong. The truth is that while I can enumerate them, the obvious candidates (changes in oil prices, interest rates, exchange rates, etc.) are likely to already be anticipated and largely priced in. It’s the surprises no one can anticipate that would more markets most if they were to happen. But (a) most people can’t imagine them and (b) most of the time they don’t happen. That’s why they’re called surprises. ... People began to ask me what inning we’re in during the financial crisis of 2008, and they’ve continued ever since.
Since I’ve written so many cautionary memos, you might conclude that I’m just a born worrier who eventually is made to be right by the operation of the cycle, as is inevitable given enough time. I absolutely cannot disprove that interpretation. But my response would be that it’s essential to take note when sentiment (and thus market behavior) crosses into too-bullish territory, even though we know rising trends may well roll on for some time, and thus that such warnings are often premature. I think it’s better to turn cautious too soon (and thus perhaps underperform for a while) rather than too late, after the downslide has begun, making it hard to trim risk, achieve exits and cut losses. ... Since I’m convinced “they” are at it again – engaging in willing risk-taking, funding risky deals and creating risky market conditions – it’s time for yet another cautionary memo. Too soon? I hope so; we’d rather make money for our clients in the next year or two than see the kind of bust that gives rise to bargains. (We all want there to be bargains, but no one’s eager to endure the price declines that create them.) Since we never know when risky behavior will bring on a market correction, I’m going to issue a warning today rather than wait until one is upon us.
- Also: The New York Times - The Car Was Repossessed, but the Debt Remains < 5min
- Also: Wall Street Journal - For Consumers, Less Debt but Lots of Bills < 5min
- Also: Bloomberg - Bankers Ditch Fat Salaries to Chase Digital Currency Riches < 5min
- Also: Business Insider - US home sales volume to Canadians surges < 5min
- Also: Bloomberg - New U.S. Subprime Boom, Same Old Sins: Auto Defaults Are Soaring