Financial cycles are often misunderstood by majority. It’s a zero sum game where transfer of money takes place from one entity to another. It’s combination of analysis, research but luck outplays every other factor. Markets react irrationally majority of the times.
Either you’re a fund manager or an individual managing your personal portfolio, what’t the #1 question that goes through your mind.
“Is this a great time to exit or enter”
There are three types of sentiments that exist in the market at any given point of time.
- Market Neutral
Every one in the market has a conviction behind his decision once he is able to identify the trends based on the information he has. General trend is to follow the trend and don’t ride against the wave, however if you look at history biggest gains are made when people went against what market was doing.
Warren in the letter explained how well the stock markets have performed & index funds was the best investment that people could’ve made, but he outlined the 3 biggest traps for any investor
- Trading too much & incurring fees
- No or little stock analysis
- Poor skills at timing the market
He also mentions that though these are the obvious ingredients for failure, they’re added to the receipt of success repeatedly
Gold mines are found when you’re patient and have your own strategy. I’ll cover the following
- Why is it a good idea to go against the market
- Why crashes always follow bubbles
- Why risk-free is actually the most riskiest approach
Before I dive into more details, let’s start with the basic notion behind investor mentality. He is always looking for one thing
Buy assets with high value at a low value. Delta between actual value & value he paid is the profit
My job is to invest in a wide variety of assets & construct a portfolio with different strategies to yield results beating the market average. History suggest than less than 33% of the people are able to beat the market average, but the returns for 33% are so high which keeps the remaining 67% in the game. Luckily, I am among the 33% so far, but I could be on other side of the table anytime.
Luck plays an important role in any investment outcome regardless of how much research one has done. Some are better at guessing by chance or by research, but no one has a crystal ball to predict accurately. Best thing an investor can do is to construct a thesis around a hypothesis, build a strategy around it with a backup plan & then discipline himself in following it. Every failure or success should take him back to the working sheet to validate or invalidate his assumptions.
While research is good, the biggest factors involving the market cycles are large-scale economical, geopolitical or market-related events including but not limited to security, war, military take-overs, political instability, natural resources discovery, big trade agreements or a technological breakthroughs. With advent of internet, every one has access to this information & now it’s up-to their intellectual ability to absorb, assess and guesstimate the impact on the markets.
There are multiple types of traders. It could either be day-trader, long term investors or just wicks scalper. Regardless of whoever you are, it’s the exact same mission. Beat the market with your decision. You can either be investing in hope of price increase, generating cash flow or just diversifying your asset to preserve capital, but every move you determine is nothing but just a speculation. Everyone is hoping to be smarter than others, but that rarely happens.
In the past, I acquired assets which were a steal but also picked up garbage that still to date I can’t believe. Biggest jackpot is when you’re able to time well. It’s like striking the ball in the right direction from middle of the bat. It’s super hard to time it well, so best is to have an exit and entry price & not worry about over optimising your gain. Just minimize your losses.
So what’s a cycle? They’re similar to any wave that you see at the ocean which comes and go however waves can be bigger or smaller. Despite their unpredictability, if you look at a longer time frame, you can have some level of confidence of the future. Example is night comes after day, but the time sun rises and set changes from season to season. We may or may not have a White Christmas in Toronto, but ruling out snow in January/February is very hard.
It’s easier to be right in the longer time frame while very difficult to be right in a short time frame. Reward to be right in a shorter time frame is higher but Risk reward ratio just doesn’t justify the action.
Today we’re fortunate enough to have access to so much information that we can plan our day very concretely. Though we don’t know if it’ll snow on 25th December, but history shows that there isn’t any January without any snowfall.
While it becomes super hard to predict a specific trend during the day, long term cycles are fairly easy to identify. We were in the longest bull run in the history with every assets giving returns that were unprecedented in the history for the last 10 years. General public does exactly opposite to Buffet suggested. People will jump into an asset class when it has already reached the peak and will shy away from getting into an asset when it has bottomed out.
Bubble-Burst cycle keep on repeating rewarding the smart, lucky and patient people while taking it away from the people on the other side.
Focus on Long term:
“There are only patterns, patterns on top of patterns, patterns that affect other patterns. Patterns hidden by patterns. Patterns within patterns.
If you watch close, history does nothing but repeat itself.
What we call chaos is just patterns we haven’t recognized. What we call random is just patterns we can’t decipher. what we can’t understand we call nonsense. What we can’t read we call gibberish.
There is no free will.
There are no variables.”
― Chuck Palahniuk
If we look at the great depression, dot-com bubble, 2008 recession or any other similar event, there are many commonalities. Biggest one is the rate at which things are changing. Similar to body, economies or growth can’t rely on steroids for long. You can have a shot here and there but overall it should have merits. Back in 2013, I recall there were only 2-3 investment firms which remained in single digits till 2017 where every one wore the hat of Blockchain VC with reported number of more than 100 in 2017.
Mushroom group of these wanna be investors was toxic because companies were raising millions in seconds where they won’t have even be able to raise 10k from traditional industry. Result bubble burst and cryptocurrencies have lost 90% of it’s market cap. This isn’t the first time it has happened and probably won’t be the last one. These however does act as a filter for part-timers. I read on this topic here
While things generally do recover, it may take much longer in few cases. Though there is more VC invested today in startups than 2008 but the house ownership hasn’t returned to even closer to numbers of 2008.
Overall, with population growth economy has to grow and research shows the poverty levels are improving as well, so there isn’t a mystery behind achieving reasonable growth. Perseverance is the goal. As they say whatever that goes up must come down.
Biggest challange with the short term mentality is to understand investor psycology. Research shows that 90% of the decisions that we do are irrational. Very few people are disciplined and our spontaneous decisions make or break our lives. We have our own mood swings, good and bad days & in few extreme cases it’s more like a pendulum from unbounded euphoria & bottomless despair.
#1 reason for short term market mentality is those pendulum mood swings. It could be euphoria-driven greed that lead you to go all in or despair-driven fear that lead you to sell everything. Either people think this is once-in-a-lifetime opportunity or the world is going to end. Biggest mistake people make is when they convince themselves that this time will be different.
Even though your heart is saying that markets are irrational, you get in for a swing trade. It just take one person to panic and the stack of cards start to follow down creating a dominos effect. Fear of greed or fear or losing, both are dangerous.
Though it’s super easy to comment on it, when you’re in the moment, it’s very hard to resist even for the best of the best.
An early example is the case of Sir Isaac Newton and the South Sea Company, which was established in the early 18th Century and granted a monopoly on trade in the South Seas in exchange for assuming England’s war debt.
Investors warmed to the appeal of this monopoly and the company’s shares began their rise.
Britain’s most celebrated scientist was not immune to the monetary charms of the South Sea Company, and in early 1720 he profited handsomely from his stake. Having cashed in his chips, he then watched with some perturbation as stock in the company continued to rise.
In the words of Lord Overstone, no warning on earth can save people determined to grow suddenly rich.
Newton went on to repurchase a good deal more South Sea Company shares at more than three times the price of his original stake, and then proceeded to lose £20,000 (which, in 1720, amounted to almost all his life savings).
This prompted him to add, allegedly, that “I can calculate the movement of stars, but not the madness of men.”
The chart of the South Sea Company’s stock price, and effectively of Newton’s emotional journey from greed to satisfaction and then from envy and more greed, ending in despair, is shown above.
Lesson learnt is that herd mentality kicks in after euphoric greed predominates kicking out all the sanity a person have.
Resisting such emotions is very very tough and I have to fight it out every time I am in that situation.
What worked has me may not work well for others but I had more success when the risks were higher. You can get a good price and if you can factor the risk, it comes out be a better deal.
People pay a premium when markets are good but they all give a massive discount when the markets are down.
While every one has access to the market data or media, very few are able to separate sentiments from rationality. I purchased few houses from foreclosure couple of years ago & I can’t believe that I was able to purchase houses for 10% of their value. Cash flow remains almost the same as well. So I bought few and sold them at rent-to-own with taking down payment higher than what I paid for the house. I wish if I knew more about it back then but there is always another time.
Many people won’t know that house prices in 2010 touched around 1945s level. 1945 as a reminder was post-world war II era when the entire world was going through a great depression. Economy, GDP, Population and other factors are no where closer to 1945, so that buy made perfect sense. Population, GDP was at-least double if not more in 2008 over 1945 but the house price levels were the same. Even though 2008 was a tough year but I was getting too much discount to pass.
While I don’t know if such times will ever return but if you’re patients, you can have success. As they say ” Let the price comes to you”
Take a longer time frame while making a decision. Population is increasing so that’s a very easy factor to account for. Facts like population, inflation, GDP are easily available. We’re producing far more kids than before, incomes levels have gone up & people are working longer hour even post-retirement. Efficiency is increasing day by day in every field of life.
While US economy is growing at 2-3% per year & regardless of how slow it looks like, it is really good however it can’t be sustained for long. Though we live in the most peaceful time of history, it doesn’t take lot of time to shift things over. This is the reason, we’ve to extend our time horizon and focus on things which are sustainable in the long run.
Here is what I would be doing if I am going into the new year as an investor
Construct a thesis around a hypothesis, build a strategy on how to achieve it with a backup plan & then discipline himself in following it. Every failure or success should take you back to the working sheet to validate or invalidate his assumptions.
Good Luck in 2019