Do you need to see the future to be a great investor? This really is the billion-dollar question. A popular misconception about successful investors is that they are blessed with greater foresight than mere mortals. This misconception holds true in all markets. In stocks, those who bought companies like Amazon (AMZN, Financial) and Google (GOOG, Financial) early on are hailed as geniuses, as are the traders and asset managers profiled in Michael Lewis’s book "The Big Short," who ‘predicted’ the 2008 financial crisis.
Lessons from history
However, I don’t think it is accurate to say that these investors could see the future. The most successful investors (and traders) don’t forecast the future, they simply look at what has already happened and position themselves accordingly.
When George Soros (Trades, Portfolio) famously shorted the British pound in 1992 based on his belief that the United Kingdom would be kicked out of the European Exchange Rate Mechanism (a system predating the Euro which sought to dampen volatility the European currency markets), many thought that he must either have foreseen the future. In reality, he simply looked at the fact that the UK was in a deep recession at the time, and that it was only a matter of time before the Bank of England was forced to cut interest rates and the value of the pound would drop below the level mandated by the ERM. Here is the lesson that investors can learn from this historical episode: most things happen well before the majority of people take notice.
Just keep your eyes open
This brings me to the most recent financial crisis. If you ask most people when the crisis began, they will tell you that it started with the collapse of Lehman Brothers in September 2008, or perhaps with the collapse of Bear Stearns in March 2008. In reality, however, the subprime credit market began to tank as early as January 2007, and by July of that year the contagion had spread to the broader credit markets. By August 2007, liquidity had begun to dry up in the money markets (where banks lend each other money), which was a real red flag for anyone who cared to take notice.
However, while this was happening, the S&P 500 continued to hover around all-time highs, and indeed would make new highs as late as October 2007. Investors continued to buy stocks in the belief that all was well, even as the most important market of all was exhibiting signs of extreme stress.
Incidentally, this is why market crashes always seem ‘unforeseeable’ by those caught out by them. By the time a bull market enters its final phase, the only people buying stocks are the ones who are most bullish - the bears have largely been wiped out, or have retreated to the sidelines, while the smart, flexible investors aren’t willing to take large or risky positions.
So don’t worry if you can’t see the future - because no one can. You don’t need to be a great forecaster, you just need to keep your eyes open.
Disclosure: The author owns no stocks mentioned.
Read more here:
- Charlie Munger: How to Be a Rational Investor
- How to Invest in Real Estate Using the Stock Market
- Guggenheim’s CIO Doesn’t Think High Prices Are Here to Stay
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