Sunday, June 17, 2012

The More Things Change

When I worked in London, the office was just a few blocks away from the incredible British Museum. Working nearby afforded the opportunity to wander over during my lunch breaks and room by room soak up as much learning as I could. It was paradise for a history junkie like me.

You can't help but appreciate as you stroll through the museum that the people who lived thousands of years ago were just as intelligent, insightful, and creative as we are today. Less educated perhaps, but just as bright. What these cultures discovered, created, and built without modern tools is indeed awe-inspiring.

King's Library, British Museum (my photo)

Nereid Monument, British Museum (my photo)
One thing that just about all ancient cultures picked up on was that nothing in this world is permanent -- everything changes and cycles are inevitable:

  • What has been will be again. What has been done will be done again. - Ecclesiastes 1:9 (c. 3rd century, BC)
  • Each thing is of like form from everlasting and comes round again in its cycle. - Marcus Aurelius (121-180 AD)
  • Life is a series of natural and spontaneous changes. Don't resist them - that only creates sorrow. Let reality be reality. Let things flow naturally forward in whatever way they like. - Lao Tzu (c. 6th century, BC)
This understanding -- that everything is in flux -- has been ingrained in the human mind for thousands of years. Why, then, do we as investors all too often forget or dismiss this understanding -- choosing instead to extrapolate recent events into the future, thinking that what is now forever shall be?

If you remember the market sentiment in early 2009, for example, you'll recall how pessimistic everything felt. It seemed like every feature in financial media had something to do with how things could stay bad or even get worse. The perma-bears were cashing in with the "I told you so's" and contending that this time things are, in fact, different. Any bulls that actually made it on air were quickly ridiculed. To be fair to the perma-bears, the opposite happened in 2007 -- the Dow 36,000 crowd dominated the airwaves, declaring the end of business cycles and such nonsense. It's precisely in these type of moments of market madness that investors can stand to profit if they listen to the underlying sentiment.

Mercurial Mr. Market

Indeed, as Howard Marks notes in The Most Important Thing, "The psychology of the investing herd moves in a regular, pendulum-like pattern -- from optimism to pessimism; from credulousness to skepticism; from fear of missing opportunity to fear of losing money; and thus from eagerness to buy and urgency to sell."

The key is to be aware of these cycles as they happen and be skeptical of investor emotions -- both overly negative or positive -- and invest accordingly. Falling in with the herd's prevailing emotion will inevitably lead to mediocre or sub-par returns, so keep your eyes and ears open for any commentaries that predict the current situation will continue indefinitely and heed Templeton's sage advice that "The four most expensive words in investing are 'This time it's different'". If you hear enough people agreeing that this time is different, that's your cue to do the opposite.

As I often say in this blog, patience is the individual investor's greatest advantage over the market. Unlike most institutional investors, nothing is forcing you to invest when the market is riding high, nor keeping you from investing when the market is down in the dumps. You are in an ideal position to profit from Mr. Market's mood swings if you're able to keep your nerve and be a contrarian when he switches from despondent to euphoric and back again.

Happy Father's Day!

@toddwenning on Twitter